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The Business of The Business of EthicsEthics

EMBA 682Business EthicsDr. Ira Bruce Sprotzer

Dated March 1, 2008

By:Chris CanoDavid FortunatiDave PelosiPrashant Rajopadhye

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AgendaAgenda

Review of the Review of the Société Générale Case Ethical Issues

– Individual– Management– Corporate– Market

Conclusions Recommendations Sources

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WorldComWorldCom– $11 Billion Accounting Fraud$11 Billion Accounting Fraud

EnronEnron– Loss of thousands of jobsLoss of thousands of jobs– $60 Billion in market value$60 Billion in market value– $2 Billion in pension plans$2 Billion in pension plans

Tyco InternationalTyco International– CEO and CFO convicted of Grand Larceny CEO and CFO convicted of Grand Larceny

and Fraud, total losses of $550 Million.and Fraud, total losses of $550 Million.

Recent and Continuing Erosion Recent and Continuing Erosion of Ethical Standards in of Ethical Standards in BusinessBusiness

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Société Générale (France)

Barings Bank (UK)

Amaranth Hedge Fund (Can)

China Aviation Oil (Singapore)

Allfirst Financial Inc. (US)

Sumitomo Corp (Japan)

Daiwa Bank (Japan) US Treas bonds

Currency Trading

Gas Market

Jet fuel

Derivatives-forex

Copper Trading

Index Trading

Erosion of Ethical Standards in Erosion of Ethical Standards in Securities TradingSecurities Trading

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Which brings us to this man…..Which brings us to this man…..

Jerome Kerviel, Jerome Kerviel,

Masters in FinanceMasters in Finance

Employed by SocGen Employed by SocGen since 2000since 2000

Two years in “Middle Two years in “Middle Office”, Compliance Office”, Compliance Dept.Dept.

Two years as Assistant Two years as Assistant TraderTrader

Currently Trader and Currently Trader and Market MakerMarket Maker

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How did he do it?How did he do it?

Made bets only Made bets only one way one way– Fictitious balance Fictitious balance

Stock Market Stock Market Indices Indices– Up or downUp or down

Job/MissionJob/Mission– Minimal riskMinimal risk– Balance positionBalance position

Prior KnowledgePrior Knowledge– Circumvent Circumvent

internal controlsinternal controls

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Incentive

FraudFraudDiamondDiamond

Opportunity

Capabilities

Rationalization

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Methods Used to Avoid ControlsMethods Used to Avoid Controls

Ensured that the characteristics of the fictitious Ensured that the characteristics of the fictitious operations limited the chances of a control (eg. He operations limited the chances of a control (eg. He chose very specific operations with no cash chose very specific operations with no cash movements or margin call and which did not movements or margin call and which did not require immediate confirmation)require immediate confirmation)

Misappropriated the IT access codes belonging to Misappropriated the IT access codes belonging to operators in order to cancel certain operationsoperators in order to cancel certain operations

Falsified documents allowing him to justify the Falsified documents allowing him to justify the entry of fictitious operationsentry of fictitious operations

Ensured that the fictitious operations involved a Ensured that the fictitious operations involved a different financial instrument to the one he had just different financial instrument to the one he had just cancelled, in order to increase his chances of not cancelled, in order to increase his chances of not being controlledbeing controlled

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TimelineTimeline

WedJan 23

Unwinding Unwinding CompleteComplete

– Board convenesBoard convenes

MonJan 21

Unwinding BeginsUnwinding Begins– Unfavorable market Unfavorable market

conditionsconditions

SunJan 20

Positions IdentifiedPositions Identified– Inform Gov of Inform Gov of

Banque de FranceBanque de France– Postpone all Postpone all

communicationcommunication

FriJan 18

Abnormal Trading Abnormal Trading DetectedDetected

ThurJan 24

Public DisclosurePublic Disclosure

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Marketplace

Key Stakeholders Key Stakeholders

Investors

Company

Management

Employees

Trader

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Ethical Considerations – Ethical Considerations – IndividualIndividual

What motivated Kerviel?What motivated Kerviel?– Inferiority ComplexInferiority Complex– EgoEgo– ArroganceArrogance

Did Kerviel believe his actions were Did Kerviel believe his actions were wrong?wrong?

Were co-workers aware of his Were co-workers aware of his activities?activities?

Is greed really good? (G.Gecko)Is greed really good? (G.Gecko)

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Ethical Considerations - Ethical Considerations - ManagementManagement How could management not have How could management not have

known what Kerviel was doing?known what Kerviel was doing? Did management look the other way Did management look the other way

for the sake of profits?for the sake of profits? What was management’s responsibility What was management’s responsibility

to review and understand Kerviel’s to review and understand Kerviel’s trading activity?trading activity?

How did his “fake” trades pass for real How did his “fake” trades pass for real ones?ones?

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Ethical Considerations - Ethical Considerations - CorporateCorporate Was there a culture of reckless risk Was there a culture of reckless risk

taking?taking?

How could the compliance department How could the compliance department not have flagged Kerviel’s positions?not have flagged Kerviel’s positions?

What internal controls were in place to What internal controls were in place to monitor and track trading activity (e.g. monitor and track trading activity (e.g. Gross vs. Net positions)?Gross vs. Net positions)?

Should companies prohibit employees Should companies prohibit employees from moving from the back office to from moving from the back office to front office?front office?

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Ethical Considerations - MarketEthical Considerations - Market

What legal or ethical obligations does a What legal or ethical obligations does a company have to disclose this type of company have to disclose this type of incident?incident?

How can an investor be sure another How can an investor be sure another company doesn’t have a similar risk?company doesn’t have a similar risk?

Should legislation be enacted to prevent Should legislation be enacted to prevent a similar problem from occurring in the a similar problem from occurring in the future (e.g. Sarbanes)?future (e.g. Sarbanes)?

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Helpful Measures in preventing Helpful Measures in preventing fraud…fraud…

Source: Assoc. of Certified Fraud Examiners – Report to the Nation (Survey of 10,000 CFE’s)

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ConclusionsConclusions

There was definitely an ethical violationThere was definitely an ethical violation

– Kerviel knew he was doing something unethical and/or illegal Kerviel knew he was doing something unethical and/or illegal but chose to do it anywaybut chose to do it anyway

Internal controls should have been strongerInternal controls should have been stronger

– The internal accounting controls should have prevented or The internal accounting controls should have prevented or detected much earlier the fraudulent activities, (e.g. Net vs. detected much earlier the fraudulent activities, (e.g. Net vs. Gross positions)Gross positions)

The leaders of Societe Generale should have managed the The leaders of Societe Generale should have managed the issue betterissue better

– Societe General should have immediately informed investors Societe General should have immediately informed investors of the fraud/magnitude, etc.of the fraud/magnitude, etc.

Management and Colleagues were complicitManagement and Colleagues were complicit

– Managers were driven by profits and too willing to “look the Managers were driven by profits and too willing to “look the other way”. The most likely did not investigate Kerviel’s other way”. The most likely did not investigate Kerviel’s positions.positions.

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RecommendationsRecommendations

IndividualIndividual– Anonymous hotline to encourage employees Anonymous hotline to encourage employees

to report rogue activitiesto report rogue activities– Standards of Ethics and Compliance Standards of Ethics and Compliance

TrainingTraining

ManagementManagement– Compliance officers should look at the

entirety of an employee's trading activity, or the person's gross positions, rather than only the net positions

– Enforce use of all vacation time– More rigorous forensic audit checks

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Recommendations (cont)Recommendations (cont)

CorporateCorporate– Sr. Leadership needs to demonstrate ethical Sr. Leadership needs to demonstrate ethical

behavior and set a tone of sound risk/reward behavior and set a tone of sound risk/reward incentivesincentives

– Systematic controls to monitor and track Systematic controls to monitor and track trading activitytrading activity

MarketMarket– Legislation should be enacted to prevent a Legislation should be enacted to prevent a

similar problem from occurring in the future similar problem from occurring in the future (corporate ethics not enough)(corporate ethics not enough)

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SourcesSources

Too Many Days on the Job, Société Générale Scandal Shows Too Many Days on the Job, Société Générale Scandal Shows Forced Vacations May Help Catch FraudstersForced Vacations May Help Catch Fraudsters– The Wall Street Journal, January 29, 2008; Page C14The Wall Street Journal, January 29, 2008; Page C14

Would a vacation for Kerviel have prevented SocGen's Would a vacation for Kerviel have prevented SocGen's woes?woes?– THE WALL STREET JOURNAL EUROPE, January 29, 2008THE WALL STREET JOURNAL EUROPE, January 29, 2008

Bonus Nightmare Scares Société Générale TradersBonus Nightmare Scares Société Générale Traders– The Wall Street Journal, February 6, 2008The Wall Street Journal, February 6, 2008

France Faults Société Générale's Controls in ReportFrance Faults Société Générale's Controls in Report– The Wall Street Journal, February 4, 2008 8:53 a.m.The Wall Street Journal, February 4, 2008 8:53 a.m.

U.S. Prosecutors Seek Tie In Société Générale CaseU.S. Prosecutors Seek Tie In Société Générale Case– The Wall Street Journal, February 6, 2008; Page C6The Wall Street Journal, February 6, 2008; Page C6

SEC Probes French Bank U.S. Investigation Of SocGen SEC Probes French Bank U.S. Investigation Of SocGen Focuses On Stock SalesFocuses On Stock Sales– The Wall Street Journal, February 5, 2008; Page A3The Wall Street Journal, February 5, 2008; Page A3

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SourcesSources

Kerviel Felt Out of His LeagueKerviel Felt Out of His League– The Wall Street Journal On-Line, January 31, 2008; Page C1The Wall Street Journal On-Line, January 31, 2008; Page C1

A Quest for Glory and a Bonus Ends in DisgraceA Quest for Glory and a Bonus Ends in Disgrace– The New York Times, January 29, 2008The New York Times, January 29, 2008

The Loss Where No One Looked How Low-Level Trader Cost The Loss Where No One Looked How Low-Level Trader Cost Société GénéraleSociété Générale– The Wall Street Journal, January 28, 2008; Page C1The Wall Street Journal, January 28, 2008; Page C1

Société Générale Blew Chances To Nab Trader Kerviel Said Société Générale Blew Chances To Nab Trader Kerviel Said to Fake Counterparts' Emails; Talk Rises of Takeoverto Fake Counterparts' Emails; Talk Rises of Takeover– The Wall Street Journal, January 29, 2008; Page A1The Wall Street Journal, January 29, 2008; Page A1

Hometown Boys: Tiny French Ville Drawn Into Hometown Boys: Tiny French Ville Drawn Into ScandalJérôme Kerviel Is Blamed In $7.2 Billion Trading Loss; ScandalJérôme Kerviel Is Blamed In $7.2 Billion Trading Loss; Mystery Surrounds BrotherMystery Surrounds Brother– The Wall Street Journal, January 28, 2008; Page A1The Wall Street Journal, January 28, 2008; Page A1

Banks' High-Tech Security Can't Keep Up With TradersBanks' High-Tech Security Can't Keep Up With Traders– The Wall Street Journal, January 30, 2008; Page A14The Wall Street Journal, January 30, 2008; Page A14

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SourcesSources

Tasks Mount for a Point ManExplaining Scandal Is Latest Tasks Mount for a Point ManExplaining Scandal Is Latest Challenge On Mustier's PlateChallenge On Mustier's Plate– The Wall Street Journal - January 29, 2008; Page A12The Wall Street Journal - January 29, 2008; Page A12

Will Bets Haunt Société Générale? Write-Downs Expected As Will Bets Haunt Société Générale? Write-Downs Expected As Mortgage-Loan Risk May Be UnderestimatedMortgage-Loan Risk May Be Underestimated– The Wall Street Journal - January 22, 2008; Page C2The Wall Street Journal - January 22, 2008; Page C2

France Presses Bank to Dump Besieged Chief Over TradingFrance Presses Bank to Dump Besieged Chief Over Trading– The Wall Street Journal, January 30, 2008; Page A1The Wall Street Journal, January 30, 2008; Page A1

SECOND CONSULTATION BY THE SERVICES OF THE SECOND CONSULTATION BY THE SERVICES OF THE INTERNAL MARKET DIRECTORATE-GENERAL OF THE INTERNAL MARKET DIRECTORATE-GENERAL OF THE EUROPEAN COMMISSIONEUROPEAN COMMISSION

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Back-Up

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Key Elements of ControlsKey Elements of Controls

Control Control Environment Environment

Risk Risk Assessment Assessment

Control Control Activities Activities

InformationInformation & &

CommComm MonitoringMonitoring

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Key Elements of ControlsKey Elements of Controls

Code of Conduct/EthicsCode of Conduct/Ethics Ethics HotlineEthics Hotline Hiring & PromotionHiring & Promotion Audit Committee oversightAudit Committee oversight Investigative processInvestigative process RemediationRemediation

Control Control Environment Environment

Risk Risk Assessment Assessment

Control Control Activities Activities

InformationInformation & &

CommComm MonitoringMonitoring

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Key Elements of ControlsKey Elements of Controls

Systematic processSystematic process Level within OrganizationLevel within Organization Likelihood and significance - magnitude & Likelihood and significance - magnitude &

impactimpact Assessing & improving relevant internal Assessing & improving relevant internal

controlscontrols Risk management team – internal/externalRisk management team – internal/external

Control Control Environment Environment

Risk Risk Assessment Assessment

Control Control Activities Activities

InformationInformation & &

CommComm MonitoringMonitoring

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Key Elements of ControlsKey Elements of Controls

Linking controls to identified risksLinking controls to identified risks Identify processes, controls & Identify processes, controls &

proceduresprocedures

Got Ira…..Got Ira…..

Control Control Environment Environment

Risk Risk Assessment Assessment

Control Control Activities Activities

InformationInformation & &

CommunicationCommunication

MonitoringMonitoring

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Key Elements of ControlsKey Elements of Controls

Information systems & technologyInformation systems & technology Knowledge ManagementKnowledge Management Training – frequency & scopeTraining – frequency & scope RenewalRenewal

Control Control Environment Environment

Risk Risk Assessment Assessment

Control Control Activities Activities

InformationInformation & &

CommunicationCommunication

MonitoringMonitoring

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Key Elements of ControlsKey Elements of Controls

Ongoing monitoring by managementOngoing monitoring by management Continual testingContinual testing Separate “after the fact” evaluations by Separate “after the fact” evaluations by

internal auditinternal audit Prepared response – discipline, legal Prepared response – discipline, legal

actionaction Refine policies & proceduresRefine policies & procedures Got Ira….Got Ira….

Control Control Environment Environment

Risk Risk Assessment Assessment

Control Control Activities Activities

InformationInformation & &

CommComm MonitoringMonitoring

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The Business of The Business of EthicsEthics

Q&AQ&A