Socgen scandal becomes murkier

My blog four days ago stated that there was perhaps more to the Socgen fraud than meets the eye, and the deluge of information since then confirms this first impression. It is pointless to even attempt to cite all the stories that have come out in the last few days and I will be very selective. Socgen’s own five page non explanation of what happened is of course mandatory reading, but the Aleablog, the Alphaville blog, the Financial Times and the Independent have been the best English sources – the truly best sources are obviously in French. Another quick observation is that the blogs have been better at covering this than the mainstream media.

The issues that emerge are the following:

• Was this a fraud at all or was this just a bet that went wrong? If it was the latter, it is similar to the subprime lending at many banks – blunders rather than frauds. There is a view that this was just a case of a trader exceeding his limits and that this kind of behaviour was common at Socgen and at other banks. There is some evidence that the prosecutor has not bought the entire Socgen story and that the courts have bought even less of it.
• Kerviel does not seem to have benefited from the frauds in as much as his bonuses were not clearly linked to the profits – the alleged bonus of €300,000 that he was offered for making profits of €1.5 billion does not suggest that a monetary motivation was at all important. The compensation proposals of Raghuram Rajan and Martin Wolf that I blogged about two weeks ago would not have helped in this case at all.
• Frank Partnoy pointed out in the Financial Times that the ranking of the losses announced by Socgen last week were as follows: (a) €3.4 billion from Socgen’s unwinding the positions abruptly into a falling market, (b) €2 billion of losses on CDOs and (c) €1.5 billion of accumulated losses on Kerviel’s positions as at the time when they were discovered. The last is clearly a small part of the total loss.
• Many obserers think that unwinding the positions abruptly during a period of market stress was not the best way of dealing with the problem.
• Socgen has been sued by shareholders for insider trading in respect of its unwinding of positions over a three day period without informing the market.
• Socgen’s statement on January 24, 2008 described Kervien’s role as “plain vanilla futures hedging”. Its detailed explanation of January 27, 2008 talked about proprietary trading and arbitrage which are quite different from what it was suggesting earlier.
• There are reports that the unauthorized trades go back to 2005 and that the derivatives exchange, Eurex, had raised a red flag in November 2007. The breakdown in controls is therefore much deeper than Socgen tries to make out.
• Socgen claimed that for his fictitious short positions, Kerviel “chose very specific operations with no cash movements or margin call and which did not require immediate confirmation” while the actual long positions “were subject to daily controls and in particular margin calls with the main clearing houses.” This implies that the €1.5 billion of accumulated losses on the positions before they were discovered would all have been cash losses which would have been funded by Socgen. That a low level trader could obtain funding on this scale without being investigated carefully is baffling to say the least.
• In my last blog entry I had speculated that the position would have been at least $50 billion in notional amount. Socgen has disclosed that the amount was much larger – it is was €50 billion. This was well in excess of the market capitalization of Socgen. Even if the fictitious trades did not require immediate confirmation, they would have require confirmation at some stage. How these positions could have evaded detection for so long is again puzzling.

Posted at 5:13 pm IST on Tue, 29 Jan 2008         permanent link

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