Societe Generale (A): The Jerome Kerviel Affair Case Solution

When it comes to the business model of the bank, the bank is trading heavily in derivatives. The fact that derivative are a major chunk of bank’s profit and accounted for 20% of the bank’s profit. The inherent nature of the derivative is such that they are more risky investment that the investments in bonds or stocks. Their value depends upon the value of the underlying assets. Being able to drive a large profit for the bank, inherent risky nature of derivatives questions the robustness of risk management practices and business model of the bank.

2. Identify the internal control systems in place to address traders and trading risk

In order to minimize the threat of losses incurred by risk full trading, there were various internal controls were planted. First of all, it was the responsibility of the trading desk manager to keep an eye on the desk that no trader should exceed the risk limit of 125 million Euros. Also, desk manger has to check the information system and data bases to oversight the trader’s activities, and profit & loss generated as a result of those activities. In 2008, another task was assigned to each risk manager and desk manager that he has to make sure that he total gross and net position of all the trades and the underlying assets were monitored and controlled.

Secondly, in order to check the exaction of the trading activities, back, and middle offices were in place. The main responsibility of which was to ensure that the handling of the transaction, to check the regulatory compliance with transactions and handle the reporting side of the transaction of on the financial statements. The job description of the back and the middle office does not allowed them to identify the fraudulent activities but only enable them to manage the operation risk and validate the compliance.

Moreover, every trader was given a secretory/assistant who was reporting under the middle and back offices. The presence of the assistants was another way to keep an eye on the activities of traders. Other than that each trader was required to take some time off (2 weeks) every year so that another trader or his supervisor could take over his account and identify any wrong activities.

3. Apply the fraud triangle to and discuss the elements found in the Kerviel affair.

There are three elements of fraud triangle that in most cases lead to indulging in fraudulent activity. Firstly, there should be an incentive in committing the fraud that could satisfy professed unsoarable economic need. Secondly, an opportunity to indulge in fraud should be there which can come from many different sources. Lastly, the person committing the fraud should talk himself into the fraud decision by making rationales such as he had an optimal decision given the circumstances.

In case Kerviel affair, the first element of incentive was in the form of earning that he was generating for the bank. He generated 25 million euros of earning from his unauthorized position. He wanted to secure a bonus of 500,000 for which had to earn 50 million euros. This was the incentive that lead him to commit unauthorized trading.