Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Socgen scandal becomes murkier

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
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
  • 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.

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