$7.1 Billion Fraud Uncovered at Société Générale

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January 24, 2008

$7.1 Billion Fraud Uncovered at Société Générale

By DAVID JOLLY

PARIS — The French bank Société Générale said Thursday that it had uncovered "an exceptional fraud" by a trader that would cost it €4.9 billion, or about $7.1 billion, and that it would seek new capital of about $8 billion.

The company, the second-largest listed bank in France, said in a statement that the fraud had been committed by a trader in charge of "plain vanilla" hedging on European index futures.

The trader, who was not identified, "had taken massive fraudulent directional positions in 2007 and 2008 far beyond his limited authority," the bank said. "Aided by his in-depth knowledge of the control procedures resulting from his former employment in the middle-office, he managed to conceal these positions through a scheme of elaborate fictitious transactions."

The bank said the fraudulent positions had been closed and the trader suspended. The incident has been thoroughly investigated and found to be a case of "isolated fraud."

The company also said it would write off $3 billion from its exposure to derivatives linked to the U.S. mortgage market, including $1.6 billion related to risks in residential housing and $800 million related to U.S. bond insurance companies. It said it was also setting aside $580 million in provisions against the risk that losses in those two areas would grow.

There was some skepticism in the market about the trading fraud disclosure.

"I am sorry, but I have a hard time buying the fact that a trader was able to set up a 'secret trade' of €4.9 billion without anybody finding out," Ion-Marc Valahu, head of trading at Amas Bank, Switzerland, told Reuters.

Société Générale said it would still post a profit for 2007 of $880 million to $1.2 billion and would pay out 45 percent of its profit in dividends.

In order to reinforce its capital, the bank said, its board decided to raise $8 billion via a rights issue of preferred shares to investors. The rights issue, the bank said, would bring its tier 1 capital ratio to 8 percent.

The bank said it had rejected an offer of resignation by its chairman, Daniel Bouton, and had given him a renewed vote of confidence.

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SocGen’s €5bn rogue trader named

By Stanley Pignal and Martin Arnold in London and Peter Thal Larsen in Davos


Société Générale said on Thursday it had discovered €7bn ($10.26bn) of losses from a rogue trader in European stock futures and big US subprime mortgage writedowns, forcing the French bank into an emergency €5.5bn share issue.

Daniel Bouton, SocGen’s long-standing chief executive and chairman, offered to resign, but this was rejected by the board after reviewing the colossal losses. These included €5bn of trading losses and €2.05bn of writedowns on exposure to US mortgages and bond insurers.

The rogue trader is Jérome Kerviel, a 31-year-old Frenchman who joined SocGen in 2000. He worked for three years in the bank’s back office before being promoted two years ago to the Delta One trading desk, handling proprietary deals in futures for European stock indices. He was based in SocGen’s Paris headquarters at La Défense.

The revelation of the fraud is a massive blow for fragile investor confidence in the banking sector, which is already reeling from multi-billion dollar writedowns at many of the biggest investment banks on Wall Street and the City of London.

It also raises serious questions about banks’ risk-management procedures and their ability to control their own trading positions. One analyst said: "This news will cast a dark cloud over the already troubled European banking sector."

SocGen said the “exceptional fraud” resulted from the purchase of huge long positions in “plain vanilla futures hedging on European equity market indices” that were “beyond his limited authority”.

The trader – likely to trigger comparisons with the UK’s Nick Leeson, who caused the collapse of Barings Bank in 1995 – had “deep knowledge” of risk-control procedures from his time at the bank’s middle-office activities, which SocGen said had allowed him to conceal his positions.

The bank said it had no more exposure to the trader’s positions, which were identified and analysed on January 19 and 20 and then unwound just as stock markets crashed unexpectedly around the world on January 21.

“The decision was made to unwind this position because it was impossible for the bank to maintain,” said Mr Bouton.

SocGen refused to give any details of the trader, who it said had confessed and been suspended pending a dismissal procedure. Mr Bouton said the trader had switched from short positions in 2007 to long positions at the start of this year “for reasons we did not understand”.

The losses are a serious setback for SocGen, which had previously told investors that it had “very limited exposure” to the turmoil in debt markets caused by the crisis in US subprime mortgages.

They could trigger fresh speculation about a possible takeover of SocGen, a perennial candidate for consolidation in the European banking sector. Mr Bouton said the bank would announce a strategic review next month.

SocGen said it would take €1.1bn of writedowns on its exposure to the US residential real estate market, €550m of losses linked to US bond insurers and €400m on other unspecified credit market risks. It had already reported €375m of writedowns linked to the credit market turmoil in the third quarter.

The bank said it expected to make a profit of €600m-€800m for 2007 – a fraction of its €5.2bn earnings the previous year. Its corporate and investment banking unit would make a loss of €2.3bn.

The plan to raise €5.5bn – to be underwritten by JP Morgan and Morgan Stanley – contrasts with the trend for US banks to raise capital from sovereign wealth funds in the Middle East or Asia.

Mr Bouton said French and foreign investors had already contacted him to express interest in taking part in the share issue.

The SocGen boss said the rogue trader’s loss had been exaggerated by difficult market conditions this week. But he defended the bank’s risk-management processes. “All our models of stress-testing work perfectly well,” he said.

Jean-Pierre Mustier, head of investment banking who had been seen as a potential successor to Mr Bouton, said the position occupied by the rogue trader was only expected to generate €20m of revenue a year. “The specific pattern of his transactions was that they used fake transactions rolled on a permanent basis,” said Mr Mustier.

SocGen said the €5.5bn capital increase would increase its tier one ratio – a measure of capital adequacy used by regulators to monitor solidity of banks – to 8 per cent after its planned acquisition of Rosbank in Russia.

After a long suspension SocGen’s shares re-opened trading down €5.21, or 6.6 per cent, at €73.85, valuing the bank at €38bn.

Analysts said talk that the French bank would now become a takeover target was helping support the share price.

Christian Noyer, governor of the Bank of France, the central bank, said: “The proof shows that a major bank, even confronted with an unprecedented fraud, conducted with a sophistication also without precedence, can be repaired in three days in a horrific market and this has finished up with a situation that is even stronger than before.”

However, the losses raised eyebrows among other regulators around the world and provoked intense debate in Davos.

Mary Schapiro, chief executive of Financial Industry Regulatory Authority, the US regulatory body which oversees broker dealers, said: ”It is quite surprising that positions of that magnitude would not have been monitored much more closely in this era of enhanced risk management.

”One would hope that every time something like this comes to light everyone redoubles their efforts at risk controls. There is always a possibility of a rogue trader at a bank so risk controls have to contemplate that possibility – that is why you have built in controls.”

Copyright The Financial Times Limited 2008