A blunder, very bad timing, and off we went on the Kerviel merry-go-round

The 11th Criminal Chamber of the Paris High Court is to deliver its verdict int the Société Générale vs Kerviel case on October 5th. This post was published in French on Slate.fr early trial in June 2010.

Traduction Valéria Costa-K

If in early January, Kerviel had not hastily changed the name of the other party for his multibillion deal, he might still be working for Société Générale. But on January 3^rd 2008 he smelled something fishy around him. He then decided to choose some German broker called Baader, as a counterparty. This made the risk evaluating programmes go wild. Three billion had to be found immediately, 10% of the bank’s total assets for just one of its 130,000 employees! And all of it just three weeks before the closure of the financial year. If the name had been Deutsche Bank, as usual, it would have gone unnoticed, but with Baader, it put grit in the works…

To understand how a little trader managed to rock of the grandest institutions in the banking world one has to go back in time. Not too far back: let’s go to Friday April 13th 2007. On Fridays, you’re always slightly less focused. It was such a beautiful day, with the sun shining over the skyscrapers in La Défense business district in Paris. The week-end would be warm with no forecasted storms. Sunny and 32 degrees Fahrenheit, according to the Météo France archives. On days like these, it is a bit harder to work.

A lire aussi : L’affaire Kerviel en 5 mots
L’affaire Kerviel en 5 histoires incroyables
L’affaire Kerviel en 5 chiffres
L’affaire Kerviel en 5 dates
L’affaire Kerviel en 5 acteurs
L’ordonnance de renvoi du juge Van Ruymbeke
Les procès verbaux d’audition de Jérôme Kerviel à la brigade financière

Despite all this Martine Auclair was on her guard. In charge of controlling operations made by traders, she had chanced on the strange financial packages of a certain Kerviel, first name Jérôme. She did not understand the whys and hows. To put it bluntly, she found his transactions suspicious. So that everybody might understand why she was alarmed, she actually wrote an email. There it was, “in black and white”, she told Judge Von Ruybemke, much later. (Read the order of conclusion of Judges Van Ruymbeke and Besst, and the official record of Jérôme Kerviel’s hearing by the financial body published on January 30th 2008 by Médiapart. Also check the very clear chronology published on Lexinter.net.)

It should have all come to a stop on that day of April 13^th 2007, if someone had paid attention to that email. But come on, the week-end was almost there… Of course Société Générale would have lost some money, 4 or 5 million euros, 10 at most. 2A – the unscrupulous trader’s codename – would have been scolded or dismissed and no one would have ever heard of  Jérôme Kerviel, born in Pont-Labbé on 11 January 1977, in the Bigouden region of Brittany. Case dismissed.

Instead, the ticking time bomb is set off by oblivious oversight on the eve of a sunny week-end. It’s all there, concentrated over a few hours, a few words, a few figures. On  April 13^th 2007 an emergency meeting is called to try and understand the trader’s bizarre acrobatics. There is mention of about a hundred million euros committed to fictitious counterparties. The “counterparty” is the person with whom you make a deal. He sells what you want to sell and buys what you want to sell. It’s no more complicated than that.

The gift of the gab but a lack of experience

This time it is quite easy to go and check: the counterparty is ClickOption, a subsidiary of Société Générale. ClickOption does not have anything in its books, no record of any deal with Kerviel. So why would he have invented the deal? To hide a loss. All audit services are familiar with the technique. Jérôme Kerviel might have little track record, but he certainly has the gift of the gab. He explains that he needed those fake counterparties to maintain operations that are real but momentarily have no one on the other side. He solves it swift and smooth, all he has to do is cancel the operation. There is nothing left to see, nothing to control. Everybody can go off for the week-end. Indeed, on  May 17^th, it’s all erased.

Why go any further? Eric Cordelle, the new deputy head of Delta One – the desk where Jérôme Kerviel works with five other traders – only started in the position a few weeks earlier. He does have good knowledge of by-products (1) and Tokyo, where he was previously based, but he does not know anything about trading. Bad choice. In 2005 Jérôme Kerviel has had a year-long training period in his trade with Alain Declerck, a skilful trader that couldn’t be fooled. And actually Declerck very well remembers the first time when his protégé crossed the line.

One operation, three broken rules.

It was in July 2005, as Declerck later told Judge Van Ruymbeke: “At some point, I saw that he was dealing with Allianz titles. I asked him what he was doing. He said that he was making money, €200,000, which surprised me. He told me he had done trading the same morning on Allianz. From my own computer I looked at the deals he had made on that day with Allianz, by checking his desk remotely. I realised that the balance was not there and that he had not made €200,000 on that day. The positions taken on that day implied positions taken on the previous day. I checked positions taken on the day before by consulting Eliot (the software recording all the operations made by traders). I saw that some of those positions had been taken in the evening.” Just like that, Jérôme Kerviel had broken three rules. He had nothing to do with Allianz actions. He bet 15 million, while his limit – which had never been clearly stated, did not exceed 1 million. And he had been betting over several days when the rule only allowed him to make intraday transactions. And more importantly, he lied to his superior about his earnings, telling him he had made €200,000 when in fact he had earned €500,000!

The same story told from the other side: “on July 4^th I had 15 million euros worth of Allianz shares up for sale. I hoped to close my position during the day in order not to show that I exceeded my limit in the daily reporting.” “But as the market did not react as I had hoped (it kept going up) I had to wait. Three days later London began to plummet. Bombs had gone off in the Tube”. He unlocked his position and made 500,000 €. The sanction? More leeway.

Alain Declerck and the desk managers remember telling off the rogue trader. All DeltaOne is summoned for a meeting to set things straight. The boss is there, the boss’s boss too… In other words, they don’t pull their punches. The culprit remembers a slightly different version: “He [the manager, whose identity has not been made public] told us he disapproved of such operations but congratulated me over my gains.” And later “Alain Declerck disapproved of my behaviour” but raised his limit to “2 or 3 million euros.” “Quite a strange way to limit an agent’s actions than to give him more leeway” Jérôme Kerviel remarks maliciously in his book.

In management schools this is called “a blurred message”, or utter nonsense. The apprentice trader has integrated a good lesson: if you win it’s fine, if you lose, then you’re in trouble. When Alain Declerck leaves Société Générale for HSBC on January 27^th 2007, Kerviel has no more boss and the new one who arrives on April 1^st has no understanding of the trade. So now the real game can begin. The fiddler on the market rather despises his new boss: “I think he was fundamentally allergic to risk”, he writes in his book. You can tell that Kerviel vision of him was something like: “We are brave knights and this poor fellow can’t even ride a horse.”

2007, from millions to billions

This time, you need a good calculator because the counting unit is now in the billions of euros. In March 2006, Jérôme Kerviel, who is then left free to think on his own, has an (excellent) intuition. The subprime market, based on subsidised mortgages, is going to fall apart, and the financial markets will crumble. “In March, the subprime issue started to raise disquiet in the banking world (…) This time I progressively engaged no less than 30bn euros. (…) I had to maintain this massive position. I did so from March to July.” A few words are enough to change the world. Using bogus counterparties Kerviel accumulates orders betting on a market meltdown that fails to come. On June the 30th he digs a more than two-billion-euro hole in the accounts (that is to say, the money available for the day). To understand better let us write the exact figure of 2,127,305,024 euros and 53 cents. The figure makes you dizzy, does it? The financial team of the bank did not bulge. Kerviel’s normal activity should have required €100,000, or €200,000 for a day at most, not 2 billion! Eric Cordelle, the new manager, did not notice anything. For Eric Cordelle, the new manager, this went completely unnoticed.

Later, he also failed to notice that the balance became positive at the end of the year. Kerviel was right and while the bank directors do not believe in a meltdown of the American real estate market, the subprime fireworks has started. Borrowers cannot pay the money back and the bank can no longer pay itself by selling the houses, since their value has plummeted. “And suddenly, in July, there was a complete head turn, bordering on panic (…). I closed down my position with a 500M euro earning. But soon enough I thought that the movement would not stop there. After the sudden slump the market started bouncing back and I took a new selling position for 30bn. After one month, Kerviel closes his positions again and wins almost 1bn euros.

When it was time to cash up Jérôme Kerviel had earned 1,554 billion euros for the bank. As a single trader cannot possibly have earned such a huge amount he disguises his earning and only declares a 55-million profit under his name. The difference between the two figures remains a mystery to us. The trader changed status. Ouachel Meskine, another DeltaOne trader expresses admiration when speaking to Judge Van Ruymbeke: “He would manage to make 400,000 euros in half a day, when I made 700,000 in a month.” The Kerviel machine was working so well that Meskine recalls a particular conversation with Eric Cordelle “Eric said he had seen Jérome take a position made of a few hundred fixed-term positions and had made 3 to 400,000 euros. Eric had said we ought to rationalise all this for 2008 and make it into a trading system.” A bit as if the French car maker Renault decided to venture out on a stolen car business.

Société Générale did not end up becoming the greatest crooks in banking history because Kerviel made one tiny mistake. A detail caused his downfall. The 30 billion that he bet twice in 2007 are overlooked. This time, he puts 50 billion on the table. Not virtually, but really. The SG buys Porsche future titles (15% of the capital of the German car manufacturer). He commits to buying Porsche shares at a fixed price of €100 within the next fortnight. If by then the market rises to 110 he simply unlocks the position, buys at a 100, sells at 110, making a gain of 10. In real life, you usually count in cents for one share and multiply by huge quantities. Kerviel intends to play with 50 billion.

One mistake and everything crumbles

Kerviel makes a mistake on the counterpart he chooses to display. He chooses a German broker, Baader. Deutsche Bank or JPMorgan would not have raised any flags, Baader did. It takes 20 seconds of bank accounting explanations: The rule is that a bank’s job is to take risks but not too big ones. All day long, computers run and calculate the risk exposition. It’s the Cook ratio. Peter Cook was not a pirate but a British banker who one day he decided that when confronted to a risk, a bank has to have its own funds or funds belonging to its clients – your funds, my funds – to be able to pay up, just in case… This is money on the side. Therefore, the Cooke ratio is the crash barrier, the plumb line of the bank. For a 50 billion bet in front of Deutsche Bank or JP Morgan, risk specialists estimate that you have to have 200 millions euros of your own funds. It may sound like a lot of money but compared to Société Générale’s 30 billion it is not really a problem. Those are well-know and respected banks, with whom SG has signed agreements. Within the established circle, there is trust.

But with this broker whose name is infamously reminiscent of the 70s, it’s another story. You go from 200,000 or 390,000 euros according certain sources, to 3 billion! And it so happened that the Banque de France required that the Paris stock exchange banks close the financial year ten days earlier. It feared the impact of the subprimes crisis on Paris and harboured some suspicion towards Société Générale. Its inspectors had actually noticed a certain offhandedness in some of the operations handled by DeltaOne! Christian Noyer, the governor of the Banque de France wanted to have all the accounts validated by the executive board and on his desk by Monday January 21st at the latest. It is Tuesday January 3^rd. There is less than 3 weeks left to square the accounts. What happens on 3rd January? Jérôme Kerviel retakes 8 forward contracts (different from future contracts, which have safeguards) and replaces Baader by ClickOption as counterparty. ClickOption is home so there is nothing easier than to check the reality of the operation. Baader’s advantage was to be almost unknown and on the other side of the Rhine, which made it safer. But the programmes that calculate the Cook ratio hit the stratosphere: 200 million, 400 million… 3 billion.

Eleven working days before year closure, it becomes an unmanageable – unsolvable problem. Unless you can switch back to another counterpart. This time, Jérôme Kerviel becomes an email forger. He makes up an email, bearing Deutshe Bank’s heading, stating that Baader is merely the middle man and makes up another bearing Baader’s heading explaining that Deutsche Bank is the end client… On January 9th he tries to cancel the forwards but he is told that at that stage Société Générale owes Baader 1.5 billion.

The week-end is coming up. From Friday 11^th to Monday 14^th, the bank’s general inspection soberly notes that “the usual calculations are completed.” Time is running out. And on Monday the 15^th, troubles resume. The financial department’s got 3 billion euros of its own funds out on a single trader (2.997 billion to be precise). On January 18^th, Mr Paolantonacci, Société Générale’s risk man, asks for an explanation. This time, Kerviel’s answers are confused and awkward. In a desperate chat session with a friend, Kerviel writes, on January 18^th January at 1:50 PM: “This time I think they’re firing me at the end of the day.” The answer from the friend comes on the same day at 4:06 PM. “Hang on in there buddy.” A few minutes later, Kerviel says: “Buddy’s dead.”

The Société Générale lawsuit will take place in the US.

Yet Jérôme Kerviel can go off to Deauville for the week-end… The week-end again, as usual. Jean-Pierre Mustier, number two at Société Générale, is alerted. He is to attend the board meeting that will take place on January 20th with clean results, and not with 3 billion floating around God-knows-where. He asks to see Jérôme Kerviel on the following day. Kerviel stands up to him for while but ends up confessing what happened. The 50 billion worth positions are closed haphazardly between Monday January 21^st and Thursday 24^th. As a result, a 6.3 billion loss from which the 1.5 billion won in 2007 can be deducted. That leaves a 4.9bn hole in the bank’s accounts.

For the French judiciary system Jérôme Kerviel is the only one who stands trial.  What his defendants call “generalised connivance”, in other words, the “as long as he won it was ok” attitude is not an offence. A mistake, sure, but not an offence. Since January 2008, Jean-Pierre Mustier has offered his resignation, which was not accepted. He then gave his earnings to charities and finally left the bank in August 2009. DeltaOne’s direct managers have been fired.

No lawsuit, therefore, against Société Générale, at least not in France. It’s another story in the US, where a class action is under way. From now to July plaintiffs and accusers are making their cases by trading documentation (3). Next Fall, the New York Federal Court Attorney (Southern district) will say if the case is substantiated and if a citizens jury is to be called up. Small American shareholders accuse the bank of having hidden the truth on its accounts, of having closed their eyes on Kerviel’s actions and blame the managers for having made money while they were loosing theirs.

PhDx

You can read : “We accuse the Société Générale of a violation of the federal laws” (1/2) and “We accuse Société Générale…” of letting Kerviel off the hook (2/2)

À LIRE ÉGALEMENT SUR L’AFFAIRE KERVIEL: L’ennemi intérieur ; L’heure du bilan ;  L’affaire comptée par Daniel Bouton ; La fracture numérique ; Kerviel et les Bisounours ; Au tour des chefs d’être cuisinés ; Procès Kerviel, procès inhumain ; Salariés de la Société Générale, jurez-vous de dire la vérité? ; Kerviel coupable, la Société Générale responsable ; Mat, l’ami imaginaire ; Trader masqué et cécité générale ;  L’abracadabrant et l’absurde ; Le témoin bienvenu ; Monsieur K. ; Kerviel, incontrôlé ; Le trader noir et la banquière blanche ; Kerviel, le procès d’un homme ; Une bourde, un très mauvais timing et l’affaire Kerviel démarrait ; Kerviel, critique de la spéculation dure ; «Nous accusons la Société Générale de violation des lois fédérales» (1/2) «Nous accusons la Société générale…» d’avoir laissé faire Kerviel (2/2)

LES POINTS DE REPÈRES: L’affaire Kerviel en 5 histoires incroyables ; L’affaire Kerviel en cinq mots; L’affaire Kerviel en 5 chiffres ; L’affaire Kerviel en 5 dates ; L’affaire Kerviel en 5 acteurs ; L’ordonnance de renvoi du juge Van Ruymbeke ; Les procès verbaux d’audition de Jérôme Kerviel à la brigade financière. Summary in english.