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SocGen Took 16 Days, 28 People to Uncover Kerviel Lie (Update1)

By Gregory Viscusi and Anne-Sylvaine Chassany



Feb. 22 (Bloomberg) -- For five days in early January, as European markets began to slide, Jerome Kerviel lied, stalled and used jargon to keep colleagues from discovering the phony bets that eventually brought him down and led Societe Generale SA to post a record trading loss.

One employee was so confused by Kerviel's explanation about why his counterparty had such a high risk level that she didn't pursue it, according to the bank's internal probe published Feb 20. She was one of four people from the back, middle and risk- management offices who initially questioned Kerviel on eight forward trades beginning Jan. 2.

The report censures the controls that Societe Generale, which helped create today's derivatives markets, says keep risk at an acceptable level. It shows that compliance officers went through the motions of carrying out controls without challenging Kerviel's explanations or probing further when he changed counterparties or canceled trades.

``It seems there was a consensual `laissez-faire' within the bank,' said Pierre Flabbee, an analyst at Landsbanki Kepler in Paris who cut his rating on the stock to ``reduce' this month. ``A trader wants to make money and can be intoxicated by success. There was apparently elasticity in the notion of limits.'

After winning by wagering on the market's decline, Kerviel had recently switched his positions to bet on a recovery of Germany's DAX Index and the pan-European Euro Stoxx Index, Societe Generale has said.

Reality and Reputation

From Jan. 2 to when the false trades were uncovered on Jan. 18, the DAX fell 8 percent, including 5.2 percent in the final week as bank officers exchanged a flurry of e-mails discussing Kerviel's unconfirmed counterparty.

Societe Generale has fallen 13 percent to 64.66 euros ($96) since the bank reported the 4.9 billion-euro net trading loss. So far, the board has backed Chief Executive Officer Daniel Bouton, 57, who has offered to resign.

The bank ranked first or second in client surveys of equity derivative firms for the past five years, according to Risk Magazine.

``This is a great demonstration of how far apart reality and reputation can be,' said Gary Clarke, head of European stocks at Schroders Plc in London, which oversees about $270 billion and holds Societe Generale shares. ``SocGen was considered the epitome of modern sophisticated derivatives management.'

`Inadequate'

Kerviel's job on the ``Delta One' trading desk was to use large volumes to arbitrage small price differences between equity index futures and forwards. Instead, he took bets on the market's direction while forging e-mails and documents to make it appear he'd hedged his positions.

Commissioned by Societe Generale's board on Jan. 30, the report says the bank failed to follow up 75 warnings about bets by Kerviel. Written by a three-person committee headed by Jean- Martin Folz, the former chief executive officer of PSA Peugeot Citroen, it concludes Kerviel acted alone.

``The brilliant thing that he realized was how inadequate their risk management system was,' said Stan Jonas, a former managing director of Fimat USA, the New York-based unit of Societe Generale's brokerage.

The real revelation of the report is that Kerviel wasn't just trading ``plain vanilla' futures, but was an active trader of options and warrants that form the heart of the bank's equity derivatives business, Jonas said.

Confused

``He was trading in the very instruments and field that were the pride and joy of SocGen's equity derivatives business,' Jonas said.

On Jan. 9, the day after a compliance officer was confused by Kerviel's answers about his counterparty, another officer twice asked Kerviel to clear up the matter.

According to the report, the case was closed on Jan. 9 when the 31-year-old trader said he'd canceled the trades and they ``wouldn't appear again.'

The matter resurfaced on Monday, Jan. 15, as the bank went through its annual exercise of reconstituting its year-end exposure to calculate regulatory capital requirements. Kerviel's trades, which were opened in December, would have required 3 billion euros to back them up.

By that evening, agents were confused by Kerviel's answers. Over the next three days, bank officers exchanged e-mails about the trades. One agent accused his colleagues of an ``excess of zeal' because the trades had already been verified.

`Upper Hand'

Late on Thursday, Jan. 17, Kerviel was summoned to a meeting where he told five bank officers that his supposed counterparty was just acting as a broker. He said the real counterparty was instead a large German bank that would have only required 390 million euros of capital to offset the trades. A court document says that bank was Deutsche Bank AG.

The next day, an officer described as ``Agent 26' went to see Kerviel. Soon after, Kerviel produced a fax purporting to be from Deutsche Bank, confirming the trade. Another agent, identified as ``27,' called his contacts at the German bank who were unable to confirm the trade.

Only at that point was Jean-Pierre Mustier, the head of Societe Generale's investment bank, contacted. Bank officials worked through the weekend to get to the bottom of the trades.

The incident highlights the inherent tension between middle offices and the trading floor.

``You have two people: one makes the bank richer and one prevents the bank from earning because of risk of loss,' said Tamar Frankel, a law professor at Boston University. ``So guess who has the upper hand?'

To contact the reporters on this story: Gregory Viscusi in Paris on [e-mail]; Anne-Sylvaine Chassany in Paris at [e-mail]

Last Updated: February 22, 2008 04:46 EST