Rogue Traders a Nightmare Scenario for Finance CEOs

Higher Rewards Tempt Greater Risk

Soaring earnings on Wall Street have left many to describe the last five years as a new gilded age. Money was easily flowing, deals were constantly being signed.

As record revenues rolled in, Wall Street's top banks rewarded their bankers handsomely in hopes of keeping poachers away and maintaining competition among colleagues on trading desks.

And as risk seemed to only offer greater rewards, those who were risk adverse were not always rewarded. Those who brought in highly profitable accounts and transactions were.

Even since the ongoing subprime mortgage and credit crisis, Wall Street firms paid out their highest bonuses to date in 2007, averaging some $33.2 billion, according to the New York State Comptroller's Office, up from $23.9 billion in 2006.

It's a trend that has had some experts nervous for a while, and now we know why.

"There's a sense of a cavalier Wild, Wild West mentality in finance, believing that, somehow, markets will always right themselves," said Jeff Sonnenfeld, senior associate dean at the Yale School of Management.

Sonnenfeld has described the trend of traders ratcheting up their risk level in hopes of greater returns as "a generation that lost its way between knowing the difference between courage and recklessness."

He said many Wall Street traders are not given the appropriate oversight from their bosses, the same scenario that led to Kerviel's misdealings.

"His drive was to be something that he wasn't," Sonnenfeld said.

Late Nights, Stealing Codes

Societe Generale continues to reveal details of just how Kerviel began making fraudulent transactions at the end of 2006 — spending late nights at the office, hacking into computer systems and stealing log-in codes to override certain trades.

All major banks have risk and compliance offices, leading many to wonder how, in an age of financial transparency, an institution such as Societe Generale could allow such a failure in checks and balances.

One has to look back at Kerviel's initial job at the bank to start putting the first pieces of the puzzle together. In 2000, Kerviel began working in Societe Generale's back office, which tracks and monitors trade executions.

For a bank, bringing someone from its back office into its trading area is a very sloppy decision, according to many experts.

Banks are multifaceted, with many departments. In addition to taking positions on trades, they provide a dealing, clearing and payment function, leaving them with many potential areas where things can go awry.

Kerviel, or "Evil Knievel," as some have called him, for his mastery of deceitful illusion, was able to use his knowledge of how trades are approved to evade detection.

Today, checks and balances at most firms include back offices and centralized clearings where more than one person has to sign off on an execution.

But as the Kerviel saga unfolds, it's apparent that there are still loopholes.

Keeping Tabs on Trading Positions

The sheer size of trading desks at major financial institutions, such as Citigroup, Lehman Brothers and, yes, Societe Generale, makes it easier for a rogue trader to slip between the cracks.

Their every move isn't as easy to observe. A sudden change in behavior could go unnoticed.

"In a big bank, superiors get moved around a lot, so they don't have that much time to get to know someone," said a major hedge fund manager, who asked that his name and firm not be revealed.

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