I’m taking a bit of a detour in my planned series of posts
on the Jerome Kerviel trial (see the links to related posts, below) in order to
talk about this week’s testimony, which has focused on Kerviel’s cover up
scheme – the “fake trades.”
The courtroom at the Palais de Justice was hearing evidence on the fifth day of the trial of the 33-year-old, who faces up to five years in prison if found guilty of breach of trust, computer abuse and forgery. The session focused on Mr Kerviel's fake trades.
In testimony interrupted by deafening claps of thunder and torrential rain, Mr Kerviel, told Dominique Pauthe, the judge, that he entered fake hedging trades not to bypass controls but to carry his real positions forward, "to be able to realise a gain for the bank". . . .
A former SocGen compliance officer also told the court yesterday that several databases would have been available to Mr Kerviel's superiors where all trading operations could be tracked.
Valérie Rolland said his superiors would also have been able to track down changes made in the data entry system to mask positions.
From the start, Société Générale has emphasized Kerviel’s “sophisticated” cover-up scheme, enabled by his intimate knowledge of the back-office system, which prevented supervisors and bank management from detecting his unauthorized trading. Kerviel may, indeed, possess valuable security knowledge and skills: shortly after his Soc Gen debacle, Kerviel was hired by Lemaire Consultants & Associés, an information-technology consultancy specializing in IT network installation and security.
But in reality, the bulk of Kerviel’s cover up consisted of the standard fare employed by most rogue traders: fake trades or other system entries designed to hide unauthorized trading activity, backed up by lies (which were never questioned by his supervisors or managers) and forged documents. As I’ll demonstrate in my next post on this topic, Kerviel’s cover-up techniques were not particularly original -- prior rogue traders at other financial institutions had successfully employed all three of his concealment mechanisms.
Moreover, Kerviel was not the only Société Générale trader engaged in trading violations and unauthorized practices. As stated by PricewaterhourseCoopers in its subsequent review of the event, Société Générale ignored common warning signs of potential problems, breeding a culture of noncompliance:
Front office activities developed against the backdrop of a strong entrepreneurial culture based on trust. The surge in Delta One trading volumes and profits was accompanied by the emergence of unauthorised practices, with limits regularly exceeded and results smoothed or transferred between traders.
Kerviel hid his unauthorized trading activity through three concealment mechanisms: (1) the entry and cancellation of fictitious transactions; (2) the entry of pairs of fictitious reverse transactions; and (3) the booking of intra-monthly “provisions” that offset earnings or losses.
First, and most simply, Kerviel entered fictitious transactions into the system in amounts sufficient to cover his unauthorized positions that were then employed in the bank’s risk and valuation calculations. Bank records show that Kerviel entered 947 transactions of this type.
Second, Kerviel entered matched trades of equal quantities at different prices to generate fictitious gains and losses. For example, on March 1, 2007, Kerviel entered a purchase for 2,266,500 Solarworld shares at EUR 63 and the sale of the same number of shares at EUR 53, creating a fictitious loss of EUR 22.7 million. Bank records reveal 115 transactions of this variety.
In order to avoid discovery through back-office attempts to confirm his trades, Kerviel cancelled these fictitious trades prior to confirmation, settlement, or control. To gain time, he entered transactions with some lag between the trade date and the confirmation, control, or settlement date. On the rare occasions when a supervisor or middle or back-office personnel questioned Kerviel regarding these transactions, he lied and forged emails or other confirming documents as support.
The third technique Kerviel employed, a mechanism known as a “provision flow,” is designed to correct modeling bias and supposedly is reserved only for trading assistants. This technique allowed Kerviel to enter positive or negative amounts modifying the values calculated by the front-office valuation system. Kerviel cancelled these provision flows before the end of the month, the only time when they were monitored. The bank’s records show that Kerviel entered such provision flows nine times.
All facts, figures, and calculations used in this post, and the sources and citations from which they are derived, are detailed here.
In my next post, Kerviel’s Fake Trades: Genius Or Copy Cat?, I’ll illustrate that these cover up techniques employed by Kerviel were remarkably similar to mechanisms successfully employed by prior rogue traders.
Related
Posts:
Kerviel’s
Fake Trades: Genius Or Copy Cat?
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
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