Unit 2 Assignment: Ethical Principles and Decision-Making

98 Business Ethics

Case 4

Jerome Kerviel: Rogue Trader or Misguided Employee? What Really Happened at the Société Générale?

Société Générale: A French Bank Globally Recognized The French banking company Société Générale (“SocGen” or “the Company”) was founded on May 4, 1864, and at the time of writing is headed by co- CEOs Philippe Citerne and Daniel Bouton. The bank has grown to serve 19.2 million individual customers in 76 countries. It employs 103,000 workers from 114 differ- ent nationalities. SocGen operates in three major businesses: retail banking and fi nancial ser vices, global investment management and ser vices, and corporate and investment banking. The core values at the Company are professionalism, team spirit, and innovation.

In 2006, SocGen ranked 67 on Fortune’s 2006 Global 500 and had man- aged to build a $72 billion position in Eu ro pe an stock index futures. The year before, the Company ranked 152 on Fortune’s list. In addition to top- line growth, SocGen also posted a more important improvement in overall profi tability, at $5.5 billion, up 42% from the prior year. It was the 14th largest company among the banking institutions on the list.

The Beginning of the Story Things were about to change for SocGen. Recent turmoil in 2006 revolved around the collapsing housing market and a mortgage industry that witnessed loan defaults in record numbers. Several banks engaged in purchasing high- risk mortgage loans, but the overall economic recession, primarily in the United States but also felt globally, constrained this bank’s fi nancial status. SocGen saw its stock price cut almost in half throughout the year, but this was not the only potential pitfall for this once robust Company. It was the actions of one rogue trader, Jerome Kerviel, that could have brought about the ultimate downfall of SocGen.

Who Is Jerome Kerviel and What Happened at the Bank? On January 24, 2008, Jerome Kerviel found himself in the international media spotlight, but not as he would have hoped. On this day, SocGen announced to the world that it had discovered a $7.14 billion trading fraud caused by a single trader, Kerviel. Additionally, a nearly $3 billion loss was posted due to the loss in investments in the U.S. subprime mortgage industry. The second largest bank in France had its shares halted to avoid a complete market collapse on the price of the stock.

From his modest roots to the upscale Paris suburb where he resided, friends and family never expected that this unmarried 31 year old could be capable of such a scandal. With a relatively modest salary ($145,700), Kerviel did not profi t from his trading scheme. He had been an employee at SocGen since 2000. He began in a monitoring support role, and oversaw the futures traders for fi ve years.

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2 Ethical Principles, Quick Tests, and Decision-Making Guidelines 99

He was then promoted to the futures trading desk. He traded Eu ro pe an futures by betting on the future per for mance of these funds. Kerviel saw his trading profi ts increase throughout 2007 as he bet that the markets would fall during this time. By the end of the year, he needed to mask his signifi cant gains, so he cre- ated fi ctional losing positions to erode his gains. These included the purchasing of 140,000 DAX futures (the German stock index: a blue chip stock market index that includes the 30 major German companies trading on the Frankfurt Stock Exchange). By mid- January, Kerviel had lost over $3 billion. He was hedging more than $73.3 billion, an amount far in excess of the trading limits created by SocGen for a single trader. This amount even exceeded SocGen’s overall market cap of $52.6 billion.

Despite fi ve levels of increased security to prevent traders from assuming positions greater than a predetermined amount, and a group compliance division in charge of monitoring trader activity, Kerviel was able to bypass internal con- trols for over two years.

Kerviel’s motive was not to steal from the bank, but to have his signifi cant trading gains catapult his career, and to cash in on a signifi cant bonus given to traders who exhibit the type of profi tability he created for the Company. Red fl ags were triggered, but e-mails to his superiors on his trading activity were ignored due to his overall profi tability for the Company. Kerviel admitted his wrongdoing, but stated that SocGen was partially responsible for not monitoring his activi- ties correctly and by having rewarded his behavior with a proposed bonus of $440,000. Kerviel stated that his actions were similar to those of other traders; he was just being labeled as the scapegoat in this investigation.

Company Reaction Once the fraud was detected in mid- January 2008, SocGen immediately re- ported it to France’s central bank, Bank of France. Over the next three trading days, SocGen employees began to unload all of Kerviel’s positions into the mar- ketplace. The Company attempted to complete this signifi cant sale of securities in a manner that would not disrupt the normal market movement. The ripple effect of this action may have created additional pressure on the already falling world markets. Some analysts speculated that this action may even have infl uenced the U.S. Federal Reserve rate cut. SocGen management denied that action after it discovered that the trading fraud had a meaningful impact on the world market- place. Co- CEO Bouton stated that the three- day sell- off was in accordance with guidelines, and that the liquidation of a position at any one time could not be more than 10% of the given market.

After Kerviel admitted his guilt, his employment was terminated along with that of his supervisors. Bouton submitted a formal resignation, along with second- in- command Phillipe Citerne; however, both were rejected by the board of direc- tors. Employees at the Company staged demonstrations where they showed their support for Bouton.

The bank has stated that since the activity was brought to light, there has been a tightening on the internal controls, so that actions such as Kerviel’s are

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100 Business Ethics

no longer possible for a trader. On January 25, 2008, SocGen took out a full- page newspaper article apologizing to its customers for the scandal. On January 30, the board announced the formation of an in de pen dent committee to investi- gate the current monitoring practices and determine what mea sures could be put in place to prevent it from happening again. The committee would enlist the ser- vices of the auditing company Pricewater houseCoopers. The Company also announced that it needed an infl ux of capital to stay afl oat, and began looking to outside help to raise $8.02 billion in new capital.

Government Reaction On January 26, 2008, Kerviel was taken into police custody for questioning re- garding his trading activity at SocGen. Three complaints were issued to police, one by SocGen and two others by small shareholders.

This event was the focus at the World Economic Forum in Davos, Switzerland, which brought to light questions on how risk is managed within organizations. French fi nance minister Christine Lagarde was assigned the task of investigating the events and compiling a report on the failure of internal controls at SocGen. The report was then publicized in an effort to prevent similar fraudulent trading events from occurring in the future. A timeline of the events leading up to the trad- ing losses was created in an effort to better understand the events that trans- pired. In the report, Lagarde stated that there should be an increase in penalties for banks that violate the commission’s set rules. The then president of France, Nicolas Sarkozy, stated that the events at SocGen did not affect the “solidity and reliability of France’s fi nancial system.” He wanted the board of directors to take action against se nior management, including Bouton.

On January 28, 2008, Kerviel was charged with unauthorized computer ac- tivity and breach of trust. Plans to charge Kerviel with fraud and misrepre sen ta- tion were also announced, which could carry a maximum prison time of seven years and fi nes of $1.1 million. At the time of writing, the fraud charge had not been accepted by the courts; however, prosecutors were seeking to appeal this to a higher court.

The government sought to prevent a hostile takeover of SocGen during this period. However, the Eu ro pe an Union was in disagreement with the French gov- ernment and stated that all bidders should be treated equally: “The same rules apply as in other takeover situations under free movement of capital rules. Poten- tial bidders are to be treated in an undiscriminatory manner.” The current standout bidder is the largest bank in France, BNP Paribas. Many competitors are contem- plating making an offer for the distressed Company— to purchase a portion or all of the bank’s assets.

Why It Happened Kerviel was able to evade detection because of his experience monitoring the traders in his early years at SocGen. Falsifying bank rec ords and computer fraud were part of the intricate scheme that he created. Kerviel knew when he would be monitored by the bank and avoided any activity during those periods.

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2 Ethical Principles, Quick Tests, and Decision-Making Guidelines 101

He created a fi ctitious company and falsifi ed trading rec ords to keep his activity under wraps. Kerviel also used other employees’ computer access codes and falsifi ed trading documents.

Related Companies with Similar Troubles In 1995, Barings, a British bank that had been in existence for more than 230 years, collapsed as the results of the actions of one futures trader, Nick Leeson. Leeson lost more than $1.38 billion when trading futures in the Asian markets.

In 1991, London- based Bank of Credit and Commerce International (BCCI) went bankrupt as the result of illegal trading activity and insider trading, losing over $10 billion.

During the late 1980s and early 1990s, Yasuo Hamanaka, a Japa nese cop- per futures trader, cost his employer, Sumitomo Copper, $2.6 billion.

Is There More to the Story? A director of SocGen, Robert Day, sold $126.1 million in shares on January 9, 2008, two weeks before the trading fraud was disclosed. He also sold $14.1 million the next day for two charitable trusts he chaired. Trading also occurred on January 18. The total trading activity amounted to $206 million. It was re- ported that Day traded during the timeframe where it was acceptable for a board member to trade shares of stock. Accusations of insider trading have been denied.

The Financial Times in London has reported that SocGen may have known about the trading activities back in November, when the Eurex derivatives ex- change questioned Kerviel’s trading positions and alerted the Company. This then calls into question the lack of oversight by the Company, and what respon- sibility SocGen has to its shareholders for this oversight. Kerviel accuses his supervisors of turning a blind eye to his activities because he was earning the Company a signifi cant amount of money. He states that his profi ts should have raised concerns because they far exceeded the pa ram e ters of the transactions he was allowed to engage in.

Corporate Controls at SocGen It has been stated that there were not enough safeguards in place to protect the bank from Kerviel’s activities. The following describes the existing safeguards and focuses on the public ethical programs that SocGen had in place.

At SocGen, the board of directors and three corporate governance com- mittees that were established in 1995 are in charge of creating and policing the Company through its internal rules and regulations. The Company engages in risk management by constantly reviewing its risk exposure in the variety of areas in which it operates. Due to the sensitivity of many of its banking projects, corpo- rate governance remains at the forefront of the bank’s activities. The three com- mittees include the audit committee (in charge of review of the Company’s draft fi nancial statements prior to submission to the board of directors), the compen- sation committee (in charge of determining executive compensation packages),

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102 Business Ethics

and the nomination committee (appoints new board members and executive offi cers).

The board of directors is responsible for the Company’s overall strategy and the adherence to its defi ned set of internal rules. The risk assessment divisions operate autonomously from the other operating units. Reporting directly to gen- eral management, this group consists of 2,000 employees who constantly mon- itor the activities of the other business units, making sure they are in compliance with the internal rules established by the board of directors. Monthly meetings are held to review strategic initiatives and all new products must fi rst receive the approval of the risk team before implementation may take place.

Internal audit groups have been put in place with the following assignments:

• Detect, mea sure, and manage the risks incurred. • Guarantee the reliability, integrity, and availability of fi nancial and manage-

ment data. • Verify the quality of the information and communications systems.

All staff members are under constant day- to- day supervision to ensure their compliance with the regulations in place.

The Compliance Department was established in 1997 and is currently re- sponsible for monitoring all banking activities so that the actions of all employees are in the best interest of the Company. A charter is in place that extends beyond local law and attempts to cover the high ethical standards set by the Company. Three key principles of the group are to work only with well- known customers, always assess the economic legitimacy of the action, and have the ability to jus- tify any stance taken.

The trading room had eight compliance staff members in 2006, with the goal of increasing this number in 2007. Anti- money laundering practices have also been in the spotlight during the last few years. In all, the group has increased over- all training for 2006 to 50,000 hours, up from 24,000 in 2005. The total number of employees trained is 18,000 individuals.

The role of information technology (IT) has also increased in order to support the corporate governance initiative. GILT (Group Insider List Tool) monitors po- tential confl icts of interest and insider- trading activity within the Company, and MUST (Monitoring of Unusual and Suspicious Transactions) is used to detect insider trading and market manipulation. The Company also has standards in place to prevent corruption on the part of Company employees and government offi cials.

A Code of Conduct has been in place since March 2005, with the goal of being a reference tool for employees that highlights the principles that the Com- pany wants its employees to uphold. The Code was created as the result of the changes in the current business environment, since employees and society alike have set a higher standard for an individual Company’s corporate responsibili- ties. Like many other companies that have a Code of Conduct, SocGen felt that

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2 Ethical Principles, Quick Tests, and Decision-Making Guidelines 103

establishing this Code was an essential part of operating in the current busi- ness environment.

The SocGen China Group has established strict controls in an effort to pre- vent internal private information and confi dential customer data from leaking to the outside marketplace. Separation is a key component in this, whereby an effort is made to eliminate the chance of confl icts of interest on sensitive projects. There is restricted access to IT programs, and any potential confl ict of interest must fi rst be approved and signed off by the Compliance Department.

Compliance structures were put in place beginning in March 2005 as a re- sult of a change in law by the French Banking and Financial Regulation Commit- tee (Regulation No. 97– 02). The secretary- general of SocGen heads the Group Compliance Committee. Through monthly meetings, members of the group iden- tify any potential risks on the part of the Company, develop ways to prevent future risks in new products, and engage in employee training in an effort to strengthen the idea of corporate compliance within the company culture.

Stakeholders and Their Roles The main stakeholder in this case is Jerome Kerviel. His actions were the primary driver behind the signifi cant losses incurred by SocGen. However, although Ker- viel may have been the focal stakeholder, there are several other primary stake- holders. Kerviel’s direct supervisors were responsible for managing his actions. Se nior management and the board of directors were responsible for implement- ing and enforcing guidelines. Employees of the Company are stakeholders since other traders’ actions may have infl uenced Kerviel’s decisions, and the Kerviel case may have jeopardized their own careers within the Company. The fi nal pri- mary stakeholders were the Company’s shareholders, who were negatively impacted by the huge trading losses at SocGen brought about by Kerviel.

Secondary stakeholders include the government, who pushed the board of directors for Bouton’s resignation, and the court systems prosecuting Kerviel and other individuals indicted on counts of insider trading. There are competitors, in- cluding BNP Paribas, who may try to take advantage of this opportunity to pur- chase a portion of SocGen’s operations at a devalued price. Finally, there is the public at large, whose confi dence was yet again shaken by another scandal within a fi nancial institution.

Potential co ali tions involved in the events leading up to the trading scandal include traders and their managers who may have ignored rules and regulations enacted by the governing committee at SocGen. Current co ali tions may include shareholders who want to be reimbursed for the management oversight. Share- holder suits may also be brought against those identifi ed as potentially engaging in insider trading. Finally, competition may be forming a co ali tion to section off the different business units of SocGen to complete a proposed buyout offer.

From the CEO’s perspective, Kerviel might be seen as directly violating the rules put in place by the governing committee. Kerviel’s managers also did not fully adhere to the established policies. The board of directors and the CEO

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104 Business Ethics

were instrumental in the creation of the guidelines. The board rejected Bou- ton’s letter of resignation and many employees have been very supportive of him, stating that he was the person who could guide the Company through this trying time.

Each stakeholder in this case had varying degrees of power. Kerviel had the power to operate with limited supervision (although this was due to his manipu- lation of the system) and to have a signifi cant impact on the overall bottom line at SocGen. The supervisors of the traders had a degree of power only over the traders, provided they were not blindsided by the traders’ fraudulent activities. The board of directors was responsible for providing strategic guidance for the Company, electing a CEO, and establishing rules and regulations for the Com- pany and its employees. The shareholders of SocGen stock had the power to vote on issues, since they are each individual own ers of the Company. The government had the power to infl uence how companies conducted business. The competitors impact the strategies a Company must undertake in order to stay ahead of its competition.

Three Primary Stakeholders and Their Obligations Kerviel had a legal obligation not to engage in fraudulent behavior; this is evi- denced by the fact that he was indicted in the French court system. His economic incentive was to make the most money possible for SocGen while minimizing risk. He was successful for two years, but as he failed to minimize overall risk, his behavior eventually caught up with him. He had an ethical responsibility to man- agement and his colleagues. He could be viewed as both a threat to the Company and a cooperative infl uence, depending on how management controlled the situ- ation.

Kerviel’s supervisors did not have as signifi cant a legal obligation as Kerviel with regard to his specifi c responsibilities and actions. However, if they had been aware of his actions and did not act, then they can be seen as enabling him to commit illegal acts. They had an economic incentive to uphold the standards that se nior management has put in place, since that is part of their job responsi- bility. Ethically, they had a responsibility to se nior management, their colleagues, and their direct reports. It was the responsibility of se nior management to work with the supervisors, and it was up to se nior management to work with the super- visors to see that rules and regulations were upheld.

The board of directors has an obligation to make sure that the employees of the Company act in accordance with the laws of the country they reside in. The board has an economic responsibility to the shareholders of stock in the Com- pany. Ethically, the board must create rules of conduct and ethical standards and practice a rule by example. The board is a supportive, low- potential- threat stakeholder that will probably cooperate with the CEO in this case.

Where Is He Now? “A lower court in France convicted Kerviel in October 2010 of forgery, breach of trust and unauthorized computer use for covering up bets worth nearly 50 billion

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2 Ethical Principles, Quick Tests, and Decision-Making Guidelines 105

euros in 2007 and 2008. By the time his trades were discovered and made pub- lic, he had amassed losses of almost 5 billion euros on those bets”, reported the Associated Press. He lost the subsequent appeal, the Paris Appeals Court upholding Kerviel’s sentence in its entirety in 2012. He is currently serving a three- year prison sentence.

Questions for Discussion 1. Is Kerviel the only guilty one in this case with regard to his actions? Also, does

the punishment fi t the crime in this case? Explain both of your answers. 2. Should other individuals and the bank be held legally responsible and liable

for Kerviel’s actions? Why or why not? Explain. 3. Describe what you believe to have been Kerviel’s personal and professional

ethics. Use the terms from this chapter as well as your own reasoning. 4. Compare your personal and professional ethics to Kerviel’s. 5. Explain how a stakeholder and issues analysis can help you understand this

case. 6. What are the lessons students in accounting, business, and or gan i za tion al

studies fi elds can take away from this case?

Sources This case was developed from material contained in the following sources:

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BNP Paribas weighs bid for Société Générale. (January 31, 2008). News A-Z. http:// newsaz .blogspot .com /2008 /01 /bnp -paribas -weighs -bid -for -societe .html, accessed February 3, 2014.

Fortune Global 500. (February 5, 2008). CNN.com. http:// money .cnn .com /magazines /fortune /global500 /2006 /snapshots /1235 .html, accessed January 7, 2014.

Ganle, E. (October 24, 2012). Rogue French Trader Jerome Kerviel’s 3- Year Sen- tence, $7 Billion Fine Upheld. Daily Finance .com. http:// www .dailyfi nance .com /2012 /10 /24 /rogue -french -trader -jerome -kerviels -3 -year -sentence -7 -billion /, accessed February 17, 2014.

Gumbel, P. (January 25, 2008). Financiers never say “sorry.” CNN.com. http:// money .cnn .com /2008 /01 /25 /magazines /fortune /gumbel _davossorry .fortune /index .htm, accessed January 7, 2014.

Gumbel, P. (February 1, 2008). 4 things I learned from Société Générale. CNN.com. http:// money .cnn .com /2008 /02 /01 /news /international /socgen _whatilearned .fortune /index .htm, accessed January 7, 2014.

Judges charge France’s “rogue trader.” (January 28, 2008). CNN.com. http:// money .cnn .com /2008 /01 /28 /news /international /france _fraud .ap /index .htm, accessed January 7, 2014.

Police raid fl at of rogue trader Jerome Kerviel (January 2008). The Telegraph. http:// www .telegraph .co .uk /fi nance /newsbysector /banksandfi nance /2783273 /Police -raid -fl at -of -rogue -trader -Jerome -Kerviel .html, accessed February 3, 2014.

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106 Business Ethics

Prosecutor seeks fraud charge for rogue trader. (January 29, 2008). CNN.com. http:// money .cnn .com /2008 /01 /29 /news /international /rogue _trader /index .htm, accessed February 3, 2014.

Rogue French trader Jerome Kerviel’s 3- year sentence, $7 billion fi ne upheld. (October 24, 2012). DailyFinance.com. http:// www .dailyfi nance .com /2012 /10 /24 /rogue -french -trader -jerome -kerviels -3 -year -sentence -7 -billion /, accessed January 7, 2014.

Rogue Société Générale trader accused of hacking computer systems. (January 28, 2008). ComputerWeekly.com. http:// www .computerweekly .com /news /2240084755 /Rogue -Societe -Generale -trader -accused -of -hacking -computer -systems, accessed February 3, 2014.

Rogue Trader at Société Générale Gets 3 Years. (October 5, 2010). New York Times. http:// www .nytimes .com /2010 /10 /06 /business /global /06bank .html ?pagewanted = all, accessed February 3, 2014.

“Rogue trader” faces preliminary charges. (January 28, 2008). CNN.com. http:// edition .cnn .com /2008 /BUSINESS /01 /28 /soeciete .generale /index .html #cnnSTCText, accessed January 7, 2014.

SocGen board rejects CEO resignation. (January 30, 2008). CNN.com. http:// money .cnn .com /2008 /01 /30 /news /international /socgen /index .htm, accessed January 7, 2014.

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