Rogue deja vu

It's a safe bet that every prudential regulator and every bank risk manager in the globe is now scrambling to discover how, once again, a relatively junior trader could construct a sophisticated fraud that cost his bank $US7.1 billion.

After similar activity by so-called "rogue traders" sank the 233-year-old Barings, cost Allied Irish Bank $1.5 billion and our own National Australia Bank $360 million, every bank in the globe was supposed to have tightened their risk controls and strengthened the separation between trading desks and their back offices and compliance units.

Yet Societe Generale, the world's biggest equities derivative trader, allowed someone now described by the governor of the Bank of France as a "genius" (but whose genius, given his junior status, presumably had passed unrecognized until now) was, according to the governor, able to breach five levels of security by doing what rogue traders always do – offsetting each unauthorized trade with a fictitious trade.

Okay, so the trader, 31-year-old Jerome Kerviel, had worked in SocGen's back office before joining its trading desk and, according to the bank's co-chief executive, Philippe Citerne, had an "intimate and perverse" knowledge of the bank's controls.

The bank is, however, one of Europe's biggest and its equities derivatives trading has been producing a big proportion – about 20 per cent – of its earnings. Normally, given their complexity and potential for loss, a bank that had such a large exposure to derivative trading would pay particularly close attention to managing its risks. Such a massive loss, no matter Kerviel's genius, could only occur if the bank's controls were inadequate or its implementation of them lax.

What's happened to SocGen is every senior banker's nightmare. A largely anonymous trader within a derivatives business turns rogue and devises a mechanism for evading detection for long enough to blow up his bank. Post-Barings, Allied Irish and NAB, however, banks around the world have devoted enormous time and money to devising fraud-proof systems, or at least systems that the limit the potential for loss.

Once the SocGen losses have been properly investigated there will presumably be a better understanding gained of how a junior trader, apparently operating alone and not seeking direct enrichment from his unauthorised activity, could cover up such large-scale trading for months.

At that point we'll know whether it was genius or, as has been the case in most trading scandals, poor risk-management systems design, and sloppy implementation of risk management procedures or both. If it is something other than genius, far more senior heads than have been lopped thus far will roll.

If $360 million of losses, immaterial in the context of NAB, could cost its CEO his job, set off a bitter boardroom stoush and ultimately lead to a complete purging of the bank's senior ranks and culture, one suspects losses of more than $US7 billion will eventually lead to casualties beyond a young trader and a few of his supervisors.