Kerviel’s Fake Trades: Genius Or Copy Cat?

 In my last post, Kerviel’s Fake Trades: The Anatomy of A Cover-Up, I began discussing the fake trades Kerviel employed to disguise his unauthorized losses (and gains).  Contrary to Société Générale’s assertions that Kerviel’s sophisticated cover-up scheme, enabled by his intimate knowledge of the back-office system, prevented supervisors and bank management from detecting his unauthorized trading, I suggested that Kerviel’s cover-up techniques were not particularly original -- prior rogue traders at other financial institutions had successfully employed variations on all three of his concealment mechanisms.

For example, the first technique employed by Kerviel—the entry of fictitious transactions—resembles one used from 2001 to 2004 by a group of four currency options traders at National Australia Bank (NAB).  The group regularly breached position and risk limits, and concealed their activity through the smoothing of profits and losses, stating incorrect rates for trades, and recording fictitious transactions. In January 2004, NAB announced that the traders had lost AUD 360 million.

The NAB traders concealed these activities by entering fictitious foreign exchange spot and option transactions into the NAB system (known as “Horizon”). The profits and losses generated by Horizon were posted to the general ledger and used for the creation of management reports and NAB’s financial statements. However, during a one-hour window between the close of the trading day and the beginning of the period when the back office began checks to verify the day’s transactions, the traders had time to reverse or remove the fictitious trades from Horizon, so that they were never verified by NAB’s back office. PricewaterhouseCoopers identified 467 fictitious spot transactions and seventy-eight fictitious options transactions in 2003. Barings’ Nick Leeson (who I already discussed in a prior post) also extensively used fictitious trades to hide his unauthorized activity.

The second technique employed by Kerviel—reverse fictitious transactions—is remarkably similar to one employed by AIB’s John Rusnak (also discussed in an earlier post), who used fictitious option trades to cover his trading losses and create the appearance that his positions were hedged.  Rusnak’s practice was to simultaneously enter fictitious offsetting options trades on the same currency, with the same counterparty, premium, and strike price, but with different expiration dates. For example, Rusnak might enter the sale of a deep-in-the-money option on Japanese yen to a client in Asia, with an expiration date today.  Such an option would involve the receipt of a large premium by AIB, but would also constitute a large liability on the bank’s balance sheet. At the same time, Rusnak would claim to have purchased an offsetting option from the same counterparty, with an expiration date several weeks or a month later. At the end of the day, AIB’s books reflected only that it held a valuable asset (a deep-in-the-money option for which the bank had supposedly paid a large premium) that concealed Rusnak’s losses on unauthorized directional spot and forward trades. (I detail Rusnak’s trades and concealment strategy here, for those wanting more information).

The third technique Kerviel employed, the “provision flow,” is also quite similar to one employed by AIB’s John Rusnak. In addition to the fake options transactions detailed above, Rusnak hid his unauthorized positions by directly manipulating the inputs into AIB’s VaR calculations.  These manipulations compromised the primary apparatus by which management monitored trading operations—and by which bank regulators monitored AIB’s capital adequacy.  Although AIB’s foreign exchange trading VaR limit thus was set at a mere $2.5 million (with $1.55 million of that allocated to Rusnak), it appeared that these risk limits were rarely exceeded. In fact, Rusnak consistently exceeded these VaR limits by a wide margin.

VaR manipulations at NAB, in contrast, followed a different—and more pernicious—pattern: because the bank lacked confidence in its VaR calculations, it simply ignored them, allowing the currency options desk to regularly exceed VaR and other limits.  Ironically, minutes from the May 2002 meeting of the NAB board committee charged with oversight of risk management and financial control indicate that the committee received a report on and discussed the foreign currency losses at AIB, but concluded that, because NAB used VaR and other measures to identify risk exposures, it was protected against such harm.

In sum, although each large rogue-trading incident varies in its particulars, each also follows a general common pattern, which I’ve tried to outline in this series of posts. Claims by Société Générale, or any other financial institution, of being taken in by original and genius fraudulent schemes should thus be approached with some degree of skepticism. 

All facts, figures, and calculations used in this post, and the sources and citations from which they are derived, are detailed here.

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Related Posts:


Kerviel’s Fake Trades: The Anatomy of A Cover-Up
On Warning Signs II: Follow The Money
On Warning Signs: You Can’t Get There From Here

Rogues Versus Scapegoats

Kerviel Trial Opens to Fanfare


Société Générale: Back In The Saddle Again



Jérôme Kerviel to Société Générale: Stand By Your Man