At First a Few Side Bets, Then Massive Speculation

Kerviel began experimenting with directional positions during his first year as a Delta One trader, creating small index futures and cash equity positions that he closed out before the end of each day. Although these trades were unrelated to Kerviel's arbitrage trading assignment, his supervising manager monitored and discussed them and allowed Kerviel to continue. In 2005, Kerviel became bolder, venturing into overnight trades. Initially, it seems that this progression was also tolerated because of the small amounts, but a €10 million overnight cash equity position drew his manager's concern in July 2005. Kerviel's next move took him over the line into fraudulent activity. In order to continue taking overnight directional positions without arousing management concerns, he began to create fictitious trades to offset them in DLP's books. This practice continued in sporadic fashion and in relatively small amounts through the end of 2006, peaking at €140 million in August, unnoticed by Kerviel's manager or any of DLP's middle or back office personnel. Meanwhile, in the other sector where trouble was brewing for Societe Generale, the first signs of distress were emerging in the U.S. residential mortgage finance market, as several subprime lenders started to report high delinquencies and the U.S. home construction index tumbled.

In January 2007, Kerviel's manager left Societe Generale to take another job. For the next two months, Kerviel was effectively unsupervised. Finally, in April 2007, a new manager was assigned to Kerviel's DLP team, but this one had no prior trading experience and received no orientation on his critical duties. Meanwhile, in the European equity markets where Kerviel traded, the accelerating U.S. residential mortgage meltdown had not yet had any impact, but the opportunity to bet on a stock market correction proved irresistible. By January 24, Kerviel's directional short position in European equity index futures had reached €850 million. During February, Kerviel increased his short position to €2.6 billion (U.S.$3.4 billion), and by the end of March it had risen to €5.5 billion. As news from the U.S. residential mortgage market continued to deteriorate in June and two Bear

Stearns collateralized debt obligation (CDO) funds collapsed, Kerviel became even bolder. By July 19, his short equity index position hit a peak of €30 billion. So far in 2007, Kerviel's accumulated mark-to-market loss was €2.2 billion, which was hidden in the fictitious forwards that he entered into GEDS's transaction system.

The forward counterparties Kerviel selected were either "pending," Societe Generale affiliates, or genuine but unsuspecting counterparties. To avoid detection, Kerviel assigned deferred start dates to these forwards, for which GEDS's internal policies did not require formal counterparty confirmations until the start date, which he could manipulate by canceling and reentering new fictitious trades. The sheer volume of this trading was not completely unnoticed. In fact, 41 queries about transaction anomalies, accounting discrepancies, and broker commissions were raised by Societe Generale's back office during the period from June 2006 to January 2008, but in each case they were satisfied by Kerviel's trade amendments, cancellations, and explanations. A summary of the queries is shown in Exhibit 23.4.

During the next four weeks, Kerviel's massive stock market bet finally paid off, as stocks around the world fell 8 percent. His short equity futures positions erased their losses and began to show profits, allowing Kerviel to gradually unwind them and accumulate €750 million in profits, which he concealed in fictitious counterparty trades and provisions. In November, stocks began to recover and Kerviel reversed his strategy by building a €30 billion portfolio of unauthorized long equity futures positions matched by fictitious offsetting trades, which he liquidated in December with a further €750 million in profits. Again, the volume of Kerviel's activity attracted notice, this time in the form of an alert from Eurex about a large (€1.2 billion) purchase of equity index futures by DLP in November, which Kerviel's manager failed to follow up.

Exhibit 23.4 Internal Queries Raised about Kerviel's Fictitious or Unauthorized Trades, 2006-2008


No. of Queries

Focus of Query

Source Department

June 2006


Pricing discrepancies

GEDS Operations

Dec. 2006 to June 2007


Earnings discrepancies

CIB Accounting

Jan. to Oct. 2007


Unidentified counterparty or broker

GEDS Operations

Jan. to Nov. 2007


Unexplained balance sheet variations

CIB Accounting

Jan. 2007 to Jan. 2008


Trade entry errors

GEDS Operations



Trade settlement discrepancy

GEDS Operations

March to Oct. 2007


P&L and provision

discrepancies, high notional amount of transactions

GEDS Operations, CIB Accounting

June to Aug. 2007


Reconciliation differences

GEDS Operations

Dec. 2007


High broker commissions

DLP trading management

Source: "Mission Green" report, General Inspection Services, Societe Generate.

As 2007 came to a close on December 31, Kerviel was careful to close out all his unauthorized trades, ending with a €1.5 billion profit hidden in fictitious forwards with Societe Generale affiliates. This was his prize for having held unauthorized directional positions in European stock indexes, in a volume equal to the bank's entire capital, during two prolonged periods of the year. Meanwhile, elsewhere in Societe Generale, concerns were mounting that CIB's exposure to U.S. subprime mortgage-backed securities could prove very costly. The first admission of its troubles occurred in October 2007 when CIB's fixed income, currencies, and commodities business unit took a €230 million write-down in its U.S. residential mortgage-related assets. Even though European equity markets ended the year close to their levels before the July correction, Societe Generale's year-end share price was still down 37 percent from its May 2007 peak.

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