In what would be the largest fraud of its kind by a rogue trader, a junior employee at French banking giant Societe Generale cost the company $7.2 billion by making disastrous bets on European stock prices through a series of unauthorized and wildly outsized transactions, the bank said Thursday.
The alleged fraud by 31-year-old Jerome Kerviel staggered Societe Generale, France’s second-largest bank. Its disclosure delivered a new blow to a European banking industry already reeling from losses on American sub-prime mortgage securities -- including a $3-billion write-down announced Thursday by Societe Generale itself.
“With everybody already quite scared about financial stocks, this creates even more of a threat to this sector,” said Olivier de la Ferriere, a financial analyst at Richelieu Finance in Paris. “There is a real confidence crisis anyway [and] this does not help.”
It also raised the possibility that the bank, in its haste to close out Kerviel’s bad bets, may have exacerbated the European stock plunge earlier this week. That decline, in turn, was partly responsible for the U.S. Federal Reserve’s extraordinary three-quarter-point interest rate cut Tuesday.
Societe Generale’s chairman, Daniel Bouton, said in a letter to shareholders that immediately after discovering the scale of the alleged fraud Saturday, he decided to liquidate Kerviel’s futures positions “in all urgency to avoid even worse consequences, given [their] size.” Futures contracts allow traders to bet on the value of securities at a later date.
Bank officials said during a conference call Thursday in Paris that they had unwound all the transactions from Monday to Wednesday before publicly disclosing the alleged fraud. They added that the bank suffered an “enormous loss” because of unfavorable market conditions but that there was no evidence Kerviel personally profited from the scheme.
The timing and nature of Societe Generale’s sales were unclear, however, as was their effect on European exchanges. Those markets plummeted more than 5% on Monday on the heels of a steep sell-off in Asian markets.
The Fed announced its rate cut early the next morning. A Fed official said the central bank was unaware of the Societe Generale situation when it took action, according to the Reuters news agency. The Fed maintained Tuesday that it dropped rates in response to “a weakening of the economic outlook” and deteriorating conditions in the financial markets.
Societe Generale’s loss swamps the previous high water mark for activity by a rogue trader set by Nicholas Leeson, who lost $1.38 billion in Asian futures and other derivatives at Barings Bank in 1995. The damage bankrupted the 233-year-old British bank, which was subsequently taken over by Dutch financial firm ING.
Bank officials and securities analysts said it was unlikely that the new scandal would have the same effect on Societe General, which was founded in 1864 and has 120,000 employees in 77 countries.
It owns, among other properties, Los Angeles-based TCW Group, the parent of Trust Co. of the West, which manages $153 billion for clients. A TCW spokesman said the firm was “in no way directly or indirectly related to any of the losses announced today by Societe Generale.”
“This is a very big bank,” said Ruth Lea, economic advisor and director at Arbuthnot Banking Group in London. “It’s not as if it’s unenviable. I’d be very surprised if it didn’t see its way through this.”
Kerviel -- whom Societe Generale executives did not name but who was identified in news reports from Europe -- began working at the bank’s back office in 2000, assigned to help create the internal programs that placed transaction limits on individual traders.
In 2005 he was moved to a trading desk, where bank officials said he was given only limited authority to hedge the bank’s trading positions in European stocks with stock index futures. This involves making countervailing bets on stocks’ future performance as an insurance policy against adverse moves in the bank’s portfolio.
His salary was pegged at 100,000 euros, or about $148,000 a year, including bonus; the bank said his trades were expected to generate a modest $20 million in revenue a year.
Instead, Bouton and other bank executives said during their conference call, Kerviel regularly exceeded his trading limits without detection, starting as early as 2006.
Using the knowledge he had gained in the back office, Kerviel concealed his actions by fabricating balancing trades, using “extremely sophisticated and varied techniques,” Bouton said in his letter to shareholders.
At least for a portion of 2007 his trading was profitable. Just before the start of the new year, however, he undertook a huge bet that European stock markets would rise in January.
Instead, they fell sharply, losing nearly 10% through last Friday. The following day, Societe Generale officials confronted Kerviel with evidence of his unauthorized trading.
He immediately confessed and was fired but spent the weekend helping managers create a liquidation strategy, the bank said.
The bank said it had filed legal charges against him and that “four or five” officers responsible for financial surveillance had also lost their jobs. But executives said they believed they had discovered the full extent of the unauthorized trading.
Bank executives said during the conference call that they could not explain the trader’s motivation, beyond the possibility that he was trying to show that the bank’s financial control procedures could be defeated. They added that they had not yet determined whether he had accomplices inside or outside the bank.
“The reasons are incomprehensible,” said Jean-Pierre Mustier, head of Societe Generale’s investment bank.
Kerviel’s lawyer, Elisabeth Meyer, said Thursday that he remained available to law enforcement officials and was “not on the run,” according to the Paris daily paper Le Figaro. French labor union officials representing bank employees told the Associated Press in Paris that they understood he had been having unspecified “family problems.”
French politicians said the events had no implications beyond the management and regulation of Societe Generale. French Prime Minister Francois Fillon called the alleged fraud a serious matter, but said “it has nothing to do with the current situation on the global financial markets.”
Bouton announced Thursday that the bank would show a profit of $875 million to $1.16 billion for 2007, a sharp decline from earnings of $7.6 billion in 2006. He said he had offered to resign after the disclosure of the fraud allegations, but the bank’s board rejected the overture.
Still, the bank said it would raise $3 billion through an emergency stock sale that was already underwritten by a consortium of other banks. The capital increase was made necessary by the trading loss as well as the write-downs from its exposure to U.S. credit securities, Bouton said.
Although Lea and other analysts speculated that the loss might make Societe Generale more vulnerable to a takeover, Bouton turned away questions about that possibility.
In trading Thursday in Paris, shares of Societe Generale sank 4.1% even as the CAC-40 index of French stocks surged 6% amid a broad rally in European equities.
Analysts said Thursday that, beyond the financial toll, the most immediate consequences of the huge loss would be directed at Societe Generale’s internal surveillance systems, which had plainly broken down.
“Where were this young man’s bosses?” asked Lea of Arbuthnot. “Who was minding him?”
Naturally, the toll caught the attention of Leeson, now a soccer club manager in Ireland. The former Barings trader told British Broadcasting Corp. that the size of the loss left him “shocked.”
Hiltzik reported from Los Angeles and Baum from Paris.