Why SG Failed to Detect the Fraud?

Societe Generale made headlines during Jan 2008 when it revealed that one of its traders made a series of unauthorized transactions over the past few years, which eventually caused a total loss of US$7.2 billion to the bank. Why did SG fail to detect the fraud?

It was reported that the 31-year-old trader Jereme Kerviel took massive "directional positions" in transactions that depend on the ability to correctly predict how the price of a security will move over time.

Kerviel had been an IT employee at SG before being moved to the bank's front office. He made over 1,000 fraudulent transactions dating back to Sep 2004 and concealed the fraud using various techniques that exploited his in-depth knowledge of the bank's computer systems and procedures. His techniques allowed him to bypass easily all the IT and process controls the bank had put in place to detect fraudulent transactions.

Last week The bank's general inspection department released a 71-page report on the incident, following a 27-page preliminary report released in Feb 2008. The report, called "Mission Green", highlighted 5 reasons the bank failed to detect Kerviel's activities despite several signs that, in retrospect, should have been obvious.

1. Supervision was lacking. Despite several internal alerts that should have triggered a closer look at his activities, Kerviel remained largely unsupervised, especially in the early part of 2007, when the bulk of his illegal activity took place. Between Sep 2004 and Jan 2007, his direct managers completely failed to detect any fraudulent activity, though there were several internal alerts. Kerviel's direct manager resigned in Jan 2007, and Kerviel did not have another manager until Apr. During this period, Kerviel was largely unsupervised and validated the earnings of his operational center himself.
2. A new desk manager assigned to Kerviel in Apr 2007 was ineffective and weak, and did not have enough support from his superiors.Kerviel's direct manager had no specific knowledge of trading practices (wow!), and no attempts were made to verify his supervisory abilities. During the second half of 2007, the desk manager and his immediate superior were caught up with other projects and in dealing with high employee turnover rates; thus distracted, they missed Kerviel's activities. The manager did not carry out an analysis of the earnings generated by his traders - a task that was supposed to be one of his primary responsibilities.
3. Several alerts by the front office got little attention and less response. Long before Kerviel's activities were unearthed in Jan 2008, there were several signals that were either simply ignored or not properly responded to. For instance, despite the suspiciously high value amount (59% of his group's earnings) and growth in Kerviel's declared earnings during 2007, no investigation or analysis was ever done. Similarly, between 28 Dec 2007 and 1 Jan 2008, there was an unusually high level of cash flow for Kerviel's primary operations center where he traded from. But no one noticed. Even two queries related to Kerviel by Europe's Eurex securities exchange did not receive much attention from Kerviel's direct manager. Neither did two alerts from SG's middle office informing Kerviel's manager of anomalies concerning Kerviel that were detected during routine reviews.
4. Kerviel's manager had an overly tolerant attitude toward intraday trading activities. Such trading by Kerviel was "unjustified" given his assignment and lack of seniority as a trader, the report noted. It was this intraday trading that gave Kerviel a context for carrying out his illegal trading activities.
5. The operations environment was critically chaotic. A "chronically" understaffed middle-office operations group, combined with fast growth and a rapid multiplication in the number of products, contributed to a chaotic operations environment, which made it easier for Kerviel to conceal his activities.

In addition, the report indicated that Kerviel may well have had an accomplice in-house an assistant who helped enter the hinky transactions. Kerviel has said repeatedly that other traders at SG followed the same practices, and that he has been made a scapegoat for others' failings in addition to his own.

Then how many "hidden" rouge traders were still staying at the bank?