Lessons from Soc Gen

The WSJ has an interesting story about Jerome Kerviel’s market-shaking gambit at Soc-Gen. A few reflections:

First, notwithstanding what you might hear occasionally from Congress and the SEC to the contrary (see, e.g., SOX 404), large risk is still inherent in the large business enterprise, and it often comes from where you least expect it. Kerviel was a low-level trader who worked in the mundane equity derivatives corner of the bank, and yet almost broke the bank. He wasn’t even a rising star like Nick Leeson.

The story says Kerviel ran up huge futures positions when he was supposed to be hedging. It seems he made it look like he was “hedging” through fake forward contracts, which didn’t set off any alarms because these contracts aren’t supposed to generate money until they close.

The unexpected nature of this reminds me of Bates v. Dresser, 251 U.S. 524, from way back in 1920. As discussed in Ribstein & Letsou, Section 9.02, the Court let the board off the hook when a cashier took almost the entire assets of the bank.  The cashier drew checks on the bank and then falsely charged the checks to various accounts (including the president’s!) or falsified the deposits ledger. The Court excused the board for not noticing the overstatement of liabilities, since it thought fraud usually showed up on the asset side. The directors didn't have to call in the passbooks and compare them with the ledger because they had no way of knowing that a fraud might be brewing. Of course the board might not be off the hook today given similar facts. But as the Soc Gen case shows, that doesn’t mean we’ve eliminated risk.

Second, everybody’s puzzled by the lack of a motive, since it’s not obvious Kerviel made any money from his transactions. But this reflects a thin understanding of human psychology. As Nick Leeson says in another article in today’s WSJ, "[t]he thing that I wanted, and I'm sure the thing that this guy wanted as well, was success. Success was the thing that drove him on...Probably his biggest fear is the fear of failure."

So if you're a manager, how do you prevent this from happening again?  Simple: just make sure you peer into every nook and cranny, and watch out not only for thieves, but for earnest employees who want to move up the ladder.

Comments

[michael webster]

I will bet you one shiny Canadian loonie to your American Eagle that when this clears we will find that Soc Gen used this opportunity to bury a bunch of really bad subprime bets.

Most of what has been reported, so far, strikes me as nonsense.

It just so happened that Soc Gen caught the rogue the day before they were going to announce a $3billion sub prime loss.

Really?