There are so many financial scandals. In our series of the biggest financial scandals in recent history, we cross continents, borders, ethnicities, and different industries. Some were financial scandals involving average Joes being scammed out of their hard-earned cash, others involved corporate fraud, insider trading, some of the biggest names on Wall Street and Ponzi schemes. A number of them have even been turned into movies, such as the Wolf of Wall Street, Madoff, and Nick Leeson who brought down Bearing bank. Some scandals involved big names such as Martha Stewart and Bernie Madoff, whereas others are less known to the wider public but had a massive impact on the financial world and corporate governance.
So in our series of biggest financial scandals, scandal five involves one of the biggest banks, a young trader, and a too-big-to-be-believable financial loss to be incurred by one individual junior bank employee.
The case of Jerome Kerviel
After a few years with Societe Generale where he had started work in, and this is not a joke, their compliance department, he moved into a junior trading position with a department that Societe Generale mysteriously dubbed Delta One. If he had been in the special forces or a Marine, this may have been a more appropriate name for a team, but Kerviel worked for a French bank. Delta One, in financial terms, describes a situation in which a hedged position is perfectly offset. For instance, if your position in Tesla shares dropped by one percent and you had hedged (or secured) that position with a put on Tesla, a Delta One would be the situation when the one percent drop in the Tesla's share price is perfectly offset by a one percent gain in your Tesla short position. However, after some stunning gains by betting on a falling market such as shorting Allianz shares and reaping hundreds and millions in profit and peaking at a reported 1.5 billion euros on December 31, 2007, Kerviel's luck came to a screeching halt losing Societe Generale 4.9 billion euros.
Who was Jerome Kerviel?
Born on the French West Coast in Brittany into a regular family with no connections to the finance industry, Kerviel later graduated from the University of Nantes in Banking and Finance with an average grade and subsequently obtaining a Finance and Investment Master from Université Lyon 2 while working at BNP. His journey into trading would first take him through the middle office at Societe Generale, where he stayed for five years, before joining the trading floor in 2005 as an arbitrage trader.
So how did Jerome Kerviel go from being a trader to becoming the main protagonist in a billion Euro trading loss for a major bank?
In essence, Kerviel would gain by buying short or long positions on the same security. If Total SA was worth € 40 in Paris and € 39.5 in New York, Kerviel would go short in Paris and long in New York. Eventually when the two prices would move closer together (Paris down, New York up), Kerviel made money. In order to make substantial amounts of money, traders often leverage their trades or borrow money. Thus even the smallest move will make an arbitrage trader significant amounts in profit.
However, an arbitrage trade requires both these trades to take place and Kerviel, due to his backgrond in the middle office, discovered how to trick the computer surveillance system into allowing him to only place one side of the bet. Kerviel made a fantastic € 1.4 billion in 2007 using his one-sided bets. As his one-sided bets grew so did his risks.
His doings were discovered in January 2008 when one of his trades broke through the risk threshold set by Societe Generale. At this point, Kerviel had bought long futures (betting on a rising market) worth around € 50 billion. This was at the midst of one of the biggest financial crisis and a falling market. As the bank was losing with every moment they held the futures, they dumped the long futures into the market driving prices even lower and leaving Societe Generale with even greater losses. A vicious cycle. By the end Kerviel had lost Societe Generale € 5 billion making him the worst rogue trader ever.
You might wonder how it was possible for Kerviel to get away with such significant trades. His early successes as an arbitrage trader making the bank significant amounts appeared to have given him a carte blanche. As one of the money makers, top management seemed to look the other way and gave him more autonomy in his tradings than most other traders would have enjoyed. It was this carte blanche that led a Parisian court to rule in the favor of Kerviel a few years later when he went head to head with his former employer. Jerome Kerviel was fired in that crucial month of January 2008.
While Societe Generale laid all blame on Jerome Kerviel, the French public viewed it slightly differently. In a survey by the broadsheet Le Figaro, 27% of respondents saw Societe Generale's top management at fault, only 13% believed that it was Kerviel who should solely be held responsible.
Kerviel was sentenced to three years in prison, but only spent 150 days (5 months) incarcerated before being placed under home arrest with an ankle bracelet in September 2014. Before commencing his prison sentence, he made headlines for walking 1,400 km from Rome to Paris after meeting the Pope in the Vatican.
While initially being ordered to repay the € 4.9 billion, an appeals court overturned the decision. Instead, a Parisian court ordered Societe Generale to pay Kerviel € 450,000 for unfair dismissal. His luck was short-lived, however, as the Court of Versailles ordered Kerviel to pay € 1 million to Societe Generale.
Who was involved in the Financial Scandal?
Victims of the Financial Scandal:
There weren't really any victims per se, unless you'd consider Kerviel's employer Societe Generale a victim for having allowed gambling of employees and thus putting itself into the situation they had found themselves in.