By Anand Prakash Jangid ACA,CISA,DISA,CISM,ACP

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Lessons to be learnt from the World Biggest
Fraud- Societe Generale

• By Anand Prakash Jangid ACA,CISA,DISA,CISM,ACP

2
Agenda

• Introduction
• The fraud
• The Man
• Event Chronology
• Controls
• Summary

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The Fraud

• January 2008 Société Générale announced that it
  lost approximately 4.9 billion( 7.2 Billion)
  due to unauthorized trading
• The bank was founded in 1984
• Operates in 82 countries and employs 151,000
  people worldwide

4
The Man
Jérôme Kerviel (born January 11, 1977) Started
his career in 2000 in the complaince dept of
SG 2005 Promoted as JUNIOR trader in the Delta
one Product team
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What so special about the fraud !!!!

• Magnitude of the event - 7 billion in losses,
  surpassing any other example of unauthorized
  trading incidents in history.
• Singly perputed by a JUNIOR trader

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How it happned

• A Junior trader(Jérôme) in SocGens Delta One
  business entered in to significant long positions
  in Eurostoxx,DAX FTSE index futures.
• In the normal course of business these long
  positions would be hedged however the trader did
  not take out genuine hedging trades

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How it Happened..cont

• The trader offset the reported market risk by
  entering in to fictitious hedge transactions.
• To avoid controls he Chose transactions with
  no cash movements or margin call which didnt
  require immediate confirmation

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How it Happened..cont

• Used other individuals passwords to cancel
  certain transaction
• Falsified documents to justify the transactions
• Ensured that the fictitious transactions were of
  a different instrument than the ones he cancelled

9
Discovery of the fraud

• The fraud was discovered when an abnormally large
  counterparty risk was detected with a large bank
  .
• When contacted the counterparty bank did not
  recognize the transactions booked against it.

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Total Exposure

• On discovery , SocGens total exposure was
  approximately 50 billion
• ( 80 billion ).
• On closing this position SocGen realised a loss
  of 4.9 billion ( 7.2 billion)

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How it happened Fictitious OTC Hedges 
Fictitious OTC Hedges
Fictitious OTC Hedges
Listed
Futures Trades Matched with exchange /
clearing house
Soc Gen pays Margin on futures positions
Trader Books Genuine Index Future trades
Futures Exchange / Clearing house
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How it happened Fictitious OTC Hedges 
Soc Gen pays Margin on futures positions
OTC
Traders books fictitious OTC Hedges to flatten
risk
Confirmation Generated to agree fictitious OTCs
with counterparty
Soc Gen calculates Collateral due from OTC
counterparty
Traders Creates Fraudulent documents emails to
justify trades
Large Bank counterparty for fictitious OTC
hedges
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Event Chronology-1

• From late 2005
• Trader starts to book fictitious hedge trades to
  disguise overall risk on his trading book
• Each time one of his trades was questioned he
  would describe it as a
• mistake cancel it then replace that
  trade with another transaction using a different
  instrument .

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Event Chronology-2

• Nov 2007
• SocGen receives a call from Eurex alerting them
  to some of this traders positions
• Questioned by the bank, he produced a fake
  document to justify the risk

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Event Chronology-3

• Early Jan 2008
• Traders being building up large index futures
  positions in DAX.
• Eurosroxx FTSE hedged by fictitious OTCs that
  will ultimately lead to this loss

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Event Chronology-4

• Jan 17, 2008
• Abnormal counterparty risk identified on a
  large bank raised to trader.
• Jan 18, 2008
• Counterparty risk concerns raised to traders
  superiors
• Confirmation email raises suspicions
• Investigation Begins

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Event Chronology-5

• Jan 19 20, 2008 ( weekend )
• Large bank does not recognize trade
• Trader admits unauthorized acts
• Full exposure calculated
• BoF informed
• Jan 21 23, 2008
• Position unwound in unfavorable markets

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Finally

• Jan 24 ,2008
• Announcement made
• World biggest fraud perpetuated by a single
  trader.

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Cause/contributory factorcont

• Trader used his experience of working in middle
  office roles to circumvent control processes
• Used other individuals passwords to cancel
  certain transactions
• Traders chose transactions with no cash
  movements or margin call which didnt require
  immediate Confirmation

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Cause/contributory factor

• Falsified electronic documents to justify the
  transactions
• Ensured that the fictitious transactions were of
  a different instrument than the ones he cancelled

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Impact cont

• Risk position accumulated was approximately 50
  billion ( 18 billion exposure to the DAX , 30
  billion to the DJ
• Euro Stoxx 50 2 billion to the FTSE 100 )
• On discovery position was down 1.5 billion

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Impact

• In the three days it took to close the position ,
  the loss had grown to 4.9 billion due to
  unfavorable market conditions
• Significant reputational impact

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Controls points reqd

• Environment
• User entitlement access controls enforcing
  segregation of duties
• Including policies requiring the business owner
  of systems to be responsible for access changes
  when user changes department
• Authorisation monitoring to monitor access
  control
• Required absence policy
•  

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Controls points reqd

• Trade Date
• Real time risk reports for trading management
• Monitoring of open interest at exchange
• Operations would escalate to trading management
  if open interest became higher than expected

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Controls points reqd

• Post Trade Date
• OTC trade confirmations ( written verbal
  electronics confirmations )
• Though industry problems with large number of
  unconfirmed trades
• Margin calls on OTC counterparties
• Even if fraudulent OTC trades booked to high
  quality counterparties, variation margin would be
  called which the counterparty may dispute

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And

• Making everyone a Risk Manager

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Risk Management - traditional silos
Strategic Risk
Business Risk
Financial Risk
Operational Risk
Who

• Business Managers
• Project Managers

• Board of Directors
• CEO

• Internal Audit
• Compliance
• IT

• CFO
• Treasurer

• Product plans
• Business reviews
• Project management

• Strategic planning
• EVA
• Balanced scorecard

• Country and credit limits
• Trading and ALM Limits
• Financial derivatives

• Controls
• Audits
• Contingency planning
• Insurance

How
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Risks faced today are highly interdependent
Enterprise-Wide Risks
FinancialRisk
OperationalRisk
Business Risk
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What is Mr. Jerome doing now ?

• Kerviel is now two weeks into a new job at
  information technology security consulting firm
  Lemaire Consultants Associates

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Questions ?????? Anand Prakash
Jangid Anandjangid_at_gmail.com 91-9845467835