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Our Take: The Rogue and You

Do banks need more heads - not just better software and hardware - to fix their well-publicized risk management problems?

And do banks play with fire when they advance back office personnel from processing and monitoring roles into direct trading jobs?

Those questions come to mind as we learn more about the actions of the rogue trader who saddled Paris-based Société Générale with more than $7 billion in losses from fraudulent trades in stock-index futures.

We don't have a good answer to either, though we're reaching out to risk managers and traders, as well as Wall Street recruiters, for their perspective. (Have thoughts? E-mail us.)

Jérôme Kerviel, 31, relied on in-depth knowledge of control procedures he'd acquired over several years working in SocGen's middle office. His bad futures bets were so large that unwinding them may have helped trigger this week's global selloff. The revelation has left egg on the corporate faces of not only SocGen - which says it had no inkling of the fraud until uncovering it last weekend - but also the Bank of France, which found nothing amiss during 17 on-site investigations at SocGen during 2006 and 2007. It's even forced U.S. Fed policy makers to confront the embarrassing possibility that a lone player's passing tornado might have snookered them into making the biggest single interest rate cut in at least two decades.

It Matters to You

Since the credit storm arrived last summer, we've suggested that risk management is likely to attract greater attention - and greater budgetary resources - from senior management. The SocGen disaster could incline managements to boost headcounts in trade oversight and monitoring.

Defending its risk management process, SocGen Chief Executive Daniel Bouton said Thursday, "All our models of stress-testing work perfectly well." In a similar vein, French central bank chief Christian Noyer denied any failure of regulatory controls, which had focused on SocGen's models for controlling exposure of "sophisticated financial derivatives and products."

These are odd comments. We thought "models" and "stress testing" are tools for gauging a bank's vulnerability to market risks. A rogue trader represents "operational risk" - a separate category, addressed with tools from a different box.

Rogue-trader incidents seem to proliferate during times of market turbulence. Now, banks the world over will face heightened pressure to demonstrate they can detect such shenanigans in time to avoid serious losses. We question whether the ability to catch rogue traders can be strengthened solely through stepped-up electronic monitoring. Alongside state-of-the-art models and systems, we suspect what's really required is more prying eyes, and more questioning lips.

Lost Opportunity for Middle-Office Staff?

A more troubling question is whether career mobility from settlement processing or risk management to a seat on a trading desk - a cherished dream for many - might get branded as unwise from a risk-control standpoint. After all, Kerviel reportedly moved through SocGen's back and middle office before ascending to the futures trading desk in 2006. Could the fact that he exploited knowledge derived from his previous work make it even harder for candidates to make that type of transition in the future?

We hope the mass of honest professionals toiling in middle-office roles won't get held back because of the actions of one individual. But it could happen. Information barriers, better known as Chinese walls, are standard in the financial world. From the C-suite to compliance, from risk management to investor relations, executives and managers head off trouble by fencing off various kinds of information from people who might be tempted to misuse it. So it would be understandable, albeit unfortunate, if some bank leaders decided that once an employee has picked up certain mid-office functions, he knows too much to trade within the same bank.

AUTHORJon Jacobs Insider Comment
  • Bo
    4 February 2008

    Kerviel was simply a "rogue" and could have come from ops, back office or Timbuktu. Key is to have setups to not even give him the chance (forced vacations, better monitoring, stiffer passwords). Obviously some serious gaps at SG.

  • SC
    3 February 2008

    I still believe people who come up the ranks in any business(paying your dues)make the most productive employees.

  • K
    3 February 2008

    As JK stated, technology will forever change, but the human capital is the key to the organization. I prefer to sow the seeds you have planted.

  • Ju
    1 February 2008

    Will it become increasingly difficult for IT/Middle Office people to move to the front office because of this fiasco?

  • JK
    1 February 2008

    i agree 1000% with your last 2 paragraphs. my middle-office is filled with talented and hungry people who dream of going to the FO and who bust their asses once they get there. thankfully most buy-side firms still believe in this. i'll take a hungry guy from the middle-office over some ivy league punk who thinks they deserve to be handed everything to them because thats what mommy and daddy did for them.

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