Just another day with the big banks

Societe Generale Uncovers Massive Fraud

By Emma Vandore
Associated Press
via Yahoo News
Thursday, January 24, 2008

http://news.yahoo.com/s/ap/20080124/ap_on_bi_ge/france_societe_generale_...

PARIS -- French bank Societe Generale said Thursday it has uncovered a $7.14 billion fraud -- one of history's biggest -- by a single futures trader whose scheme of fictitious transactions was discovered as stock markets began to stumble in recent days.

CEO Daniel Bouton said the trader's motivations were "irrational," netting the trader no personal financial gains.

A person familiar with the case named the trader as Jerome Kerviel. Bank officials said earlier the trader was a Frenchman in his 30s who probably acted alone. The person spoke on condition of anonymity because of the sensitivity of the case.

The bombshell announcement destabilized a major bank already heavily exposed to the subprime crisis and rattled the global banking sector. France's second largest bank said it will seek 5.5 billion euros ($8.02 billion) in new capital.

Societe Generale says it has filed complaint with French prosecutor against the trader. Prosecutors opened a preliminary investigation into the case earlier Thursday based on a complaint filed by a small shareholder, a judicial official said.

Trading in Societe Generale's shares, which have lost nearly half their value over the past six months, was suspended Thursday morning. When trading resumed midday, the bank's shares dropped 5.5 percent to 74.77 euros ($108.97).

Societe Generale said it detected the fraud over the weekend at its French markets division.

Once uncovered, Bouton said the bank alerted market regulators and moved immediately to close the trader's positions, incurring heavy losses amid sharp declines on world markets.

"Detecting the fraud over the weekend was problematic because world stock markets on Monday and Tuesday fell hugely around the world," said Janine Dow, senior director at Fitch Ratings financial institution group in Paris. "When the positions had to be unwound, the bank did that in a terrible market of falling equities."

The bank said the trader has misled investors since 2007 through a "scheme of elaborate fictitious transactions." The trader, who was not named, used his knowledge of the group's security systems to conceal fraudulent positions, the bank said.

"In hindsight, it was this guy's superior knowledge of the control system of every aspect of trading at the bank that allowed him to build up fraudulent positions and hide them," Dow said.

The man acknowledged the fraud, the bank said, and was being dismissed. Four or five of his supervisors were to leave the group. Bouton offered his resignation but it was rejected by the board.

The trader had worked for the bank since 2000 and earned a salary and bonus of less than 100,000 euros ($145,700), executives said.

"I'm convinced he acted alone," said Jean-Pierre Mustier, chief executive of the bank's corporate and investment banking, who interviewed the trader when the fraud was uncovered.

The trader was responsible for basic futures hedging on European equity market indices, the company said, betting on how the markets would perform at a future date.

The Bank of France, the country's central bank, said it was informed of the fraud and was investigating.

The trader had until last year been betting that markets would fall, but then changed his position at the start of this year to bet they would rise, said Kinner Lakhani, an analyst at ABN Amro in London who specializes in Societe Generale shares, citing the bank's management.

There had been "daily rumors" this week that something had gone wrong at Societe Generale, he said.

"The market was sniffing something," Lakhani said.

Because the trader previously had worked in trading accounting offices, "he would have known how the risk management worked," Lakhani said. In an extended conference call with analysts Thursday morning, bank officials "talked about this guy bypassing systems and setting up false counter-trades."

"Everyone clearly is very surprised, to say the least," he said.

The fraud appears to be the largest ever by a single trader. If confirmed, it would far outstrip the Nick Leeson trading scandal in 1995 that bankrupted British bank Barings. Barings collapsed after Leeson, the bank's Singapore general manager of futures trading, lost 860 million pounds -- then worth $1.38 billion -- on Asian futures markets, wiping out the bank's cash reserves. The company had been in business for more than 230 years.

The fraud was not as big as the 1991 scandal that led to the demise of the Bank of Credit and Commerce International. Claims by depositors and creditors there exceeded $10 billion at the time.

The Bank of Credit and Commerce International failed after a 1991 scandal that led to claims by depositors and creditors exceeding $10 billion at the time.

Gilles Glicenstein, president of asset management at rival French bank BNP Paribas -- France's largest -- said, "It shows that we are in a very troubled period for banks, and I think that it's in such troubled periods that difficult things happen."

"This is not good news for Societe Generale, but also for banks in general. It can create doubt, but at the same time in this period, we are making efforts to be transparent in order to give confidence back," he said at the World Economic Forum in Davos, Switzerland.

Axel Pierron, senior analyst at Celent, an international financial research and consulting firm, was stunned that a trader could be involved in such a massive fraud 13 years after the Barings Bank collapse.

"The situation reveals that banks, despite the implementation of sophisticated risk management solutions, are still under the threat that an employee with a good understanding of the risk management processes can getting round them to hide his losses," he said.

At Societe Generale, the fraud announcement came on the back of subprime-related difficulties. Subprime writedowns linked to the crisis in financial markets amounted to 2.05 billion euros ($2.99 billion), Societe Generale said.

As a result, the bank is planning a capital hike in the "following weeks" by selling shares in a rights offer underwritten by JPMorgan Chase & Co. and Morgan Stanley. Following the transaction, the bank's Tier 1 ratio, a measure of its financial strength, will rise to 8 percent from 6.7 percent.

The write-down and losses will lead the company to post a net profit of 600 million euros to 800 million euros ($874 million to $1.16 billion) for all of 2007, the Paris-based bank said.

Full-year results will be announced Feb. 21. In 2006, net profit was 5.2 billion euros.

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AP writers Matt Moore in Davos, Switzerland, and Thomas Wagner in London, and John Leicester in Paris contributed to this report.

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