Saturday, January 26, 2008

$7.2 billion French Fraud?

Trader Kerviel Taken Into Custody

By AP | 26 January 2008

A rogue trader who cost France's Société Générale bank more than $7 billion by making bad stock market bets to the tune of $70 billion was taken into custody on Saturday for questioning, judicial officials said.

Financial police in Paris were to question Jerome Kerviel as part of a probe into Société Générale's announcement Thursday that the 31-year-old trader had put tens of billions of dollars at risk in one of history's biggest frauds, judicial officials said. They spoke on condition of anonymity because the investigation is ongoing.

Skeptics from Mr. Kerviel's neighbors to France's prime minister have questioned whether a single, junior futures trader could have managed such large sums. Adding to the mystery, the bank said Mr. Kerviel may not have made any personal gain from his unauthorized trades.

The bank said it "discovered the fraud" last weekend and unwound the trader's losing bets starting Monday, when world markets tumbled. Some analysts have questioned whether Société Générale exacerbated the fall and indirectly led to the U.S. Federal Reserve's subsequent decision to cut rates.

Judicial officials also confirmed police searched Mr. Kerviel's apartment in the Paris suburb of Neuilly-sur-Seine. They said police also went Friday night to the bank's headquarters, where they were provided with documents relating to the investigation, officials said. Paris prosecutors are conducting a preliminary investigation based on three complaints: one by the bank accusing Mr. Kerviel of fraud, and two by small shareholders. The bank maintains it was the biggest loser in the case, because of the timing of the discovery.

Mr. Kerviel had been investing the bank's money by hedging on European equity market indices. That means he made bets on how the markets would perform at a future date. Société Générale's chief executive, Daniel Bouton, said the trader had been betting throughout 2007 that markets would fall[!?!] But the bank says he had overstepped his authority and was wagering more money than he should have. Ultimately it took three days to close the positions, and the bank lost $7.2 billion.

French presidential aide Raymond Soubie said the trader had been dealing with more than $73.3 billion. That figure outstrips the bank's market capitalization of $52.6 billion, and is close to the annual GDP of entire nations such Slovakia, Qatar or Libya. It remains unclear whether Mr. Kerviel's actions, if proved, were out of malevolence, ambition or some other reason. Three union officials representing Société Générale employees said managers at the bank who briefed them about the fraud told them Mr. Kerviel was having family problems[!?!]

The debacle generated buzz at the World Economic Forum in Davos, Switzerland, and raised questions sector-wide about risk management. French Finance Minister Christine Lagarde, speaking Saturday in Davos, said she has been asked to compile a report on the fraud. Ms. Lagarde said her report will look at "the reality of facts based on real hard data," and "how and why the controls did not work" to prevent the fraud. Ms. Lagarde said the report, whose results are to be made public, will address "what additional controls should be put in place to stop it happening again."

Société Générale's shares have lost nearly half their value over the past six months. After an up-and-down day Friday, the shares closed down 2.5% at $108.62. The company, which also posted another $2.99 billion subprime-related loss, planned to raise $8.02 billion in new capital.

Société Générale's Damage Control
After Alleged Fraud, French Bank Strives To Save Reputation

By David Gauthier-Villars | 26 January 2008

PARIS— For 72 hours this past week, top executives at Société Générale scrambled to save their company. Now, after a massive fraud that the French bank said cost it €4.9 billion ($7.2 billion), management faces another tough task: saving the firm's reputation.

In a telephone interview yesterday, Jean-Pierre Mustier, the head of Société Générale's investment-banking arm, said supervisors of the 31-year-old employee allegedly responsible for fraudulent trading missed several opportunities to stop him.

Missed Opportunities: The company credits swift intervention with allowing it to limit losses. But a senior executive says the French bank missed several opportunities to stop the alleged illicit actions of the junior trader. The trader caught the attention of back-office supervisors several times in recent months with unusual positions, Mr. Mustier said. "In some cases, he would tell them that it was a mistake," he said. "He would convince them, for example, by canceling the positions." Mr. Mustier said initial evidence of repeated lack of supervisory oversight is emerging in an internal investigation that Société Générale started after top executives learned of the alleged irregularities on Jan. 18. The bank said it was dismissing four to five people.

In disclosing the world's biggest-ever trading loss Thursday, Société Générale blamed fraudulent trades by Jérôme Kerviel, a junior trader on the bank's futures-trading desk in Paris. According to people familiar with the matter, the bank's total exposure had reached €50 billion by Jan 18.

Paris prosecutors have launched a preliminary criminal investigation into Mr. Kerviel's actions, though no charges have been pressed. Shareholders also have launched a complaint with Paris prosecutors. Mr. Kerviel's lawyer couldn't be reached for comment yesterday. An associate attorney said on Thursday that the trader was ready to answer to French justice.

In his interview Friday, Mr. Mustier said that after discovering the problem, Société Générale on Monday introduced new control systems to the back office of the bank's trading desk. Nonetheless, if Société Générale's internal inquiry finds a serious breakdown in supervisory control, it would add to pressure on the bank's embattled top executives. "They were strong, independent and a bit cocky, and now this whole fiasco has made the bank and its management vulnerable," said Bruno Berry, an equity-fund manager at Morley Asset Management in London, who owns Société Générale stock.

Mr. Mustier said he first learned of problems in the bank's futures-trading unit at 10 p.m. on Jan. 18. Philippe Citerne, co-chief executive of Société Générale, said he was warned at about the same time. The two executives said it took them two days to grasp the scope of the problem and map out a strategy to unwind the estimated €50 billion exposure they said was built up by Mr.Kerviel.

According to accounts from Mr. Mustier and other Société Générale executives, Mr. Kerviel managed to circumvent the bank's high-priced and complex security system to make trades over the past several months. Bank executives said Mr. Kerviel's alleged subterfuge was fairly straightforward. He was making large bets that European stock indexes, such as the CAC in Paris and the DAX in Frankfurt, would rise, they said. But the markets began working against him earlier this year, and the trader began racking up huge losses. Mr. Kerviel, according to bank executives, covered up those losses by recording fictitious trades[!?!] that went in the opposite direction.

Bank executives said Mr. Kerviel was acting alone. Some in the financial world have expressed skepticism of that assertion, considering the layers of controls that banks have in place in order to keep tabs on their traders' activities; experts question how a junior trader was able to gain intimate knowledge of settlement procedures and schedules, for example. Banks are supposed keep those operations completely separate as a safety mechanism. Bank executives said Mr. Kerviel was deeply knowledgeable of procedures because he had worked in the bank's so-called back office for several years. Moreover, the trader had kept up friendships in that section of the bank, possibly allowing him to keep up with the latest security features, they said. Mr. Mustier said Mr. Kerviel may have used the login and password of some colleagues to enter some transactions into the computer.

Société Générale executives say that Mr. Kerviel knew when checks were conducted. To prevent the bank's supervisors from uncovering the fictitious positions, he would erase them right before the checks and rebuild new ones immediately after, to ensure that his real positions were properly offset and concealed. Mr. Kerviel further would offset real positions that triggered real margin calls with fictitious positions, such as bets on forwards, that didn't trigger margin calls, Mr. Mustier said.

The real positions were significantly beyond Mr. Kerviel's authorized limit— the trader's annual target was to earn between €10 million and €15 million for the bank— but well within Société Générale's overall daily volume of transactions. Since the real and fake transactions balanced each other out, "we could not see anything," said Mr. Mustier. After studying the trading irregularities all weekend with Mr. Mustier, Mr. Citerne took the lead in a three-day selling marathon to unwind the massive positions allegedly created by Mr. Kurvier, according to the bank's investment-banking chief.

Société Générale's market capitalization is currently about €34 billion— a figure far less than the losses it was facing. By keeping knowledge of the problem only to a tight circle of insiders, Mr. Citerne was able to act fast. This secrecy, however, has raised questions over how many people actually knew what was going on at Société Générale while its securities were trading. Société Générale Chairman Daniel Bouton said Thursday that although he has a duty to disclose information to shareholders, he acted in the interest of the bank.

Société Générale’s Sales May Have Incited Market Plunge

By Nelson D. Schwartz and Nicola Clark, NYT | 26 January 2008

PARIS— As panic swept European markets on Monday, word spread that a big hedge fund was in trouble and dumping stocks. Someone was selling, all right— Société Générale. The French bank was frantically unwinding an estimated $75 billion of bad bets on European stocks placed by a rogue trader, Jérôme Kerviel.

As the bank struggled on Friday to determine how Mr. Kerviel could have run up $7.2 billion in losses before anyone caught on, the scope— and global impact— of his fraud began to emerge. From his desk in the middle of the trading floor on the sixth floor of Société Générale’s Alicante building in the La Défense business district outside Paris, Mr. Kerviel, 31, took huge bullish positions on the Dow Jones Euro Stoxx 50 index and the German DAX in particular, according to a fellow trader still working there who insisted on anonymity.

Société Générale rushed to unwind those trades during Monday’s market plunge, and trading in those futures contracts soared to record levels. The bank’s abrupt reversal contributed to a decline that snowballed into an avalanche of sell orders around the world, some traders said. The ensuing turmoil helped prompt the Federal Reserve to orchestrate the surprise cut in interest rates announced Tuesday.

"I have little doubt that Société Générale’s unwinding of those positions absolutely pressured indexes worldwide," said Barry L. Ritholtz, chief executive of FusionIQ, a New York-based investment research and money management firm. "And wouldn’t it be embarrassing if the Fed had to make one of the biggest emergency rate cuts ever because of some rogue trader?"

Granted, fears of a recession in the United States and continuing worries about the spread of the subprime mortgage collapse were also responsible for the market downdraft in the last 10 days. But Mr. Ritholtz argued the rapid move by Société Générale to close out tens of billions in futures positions might have been a major factor in pushing an already nervous market into an outright panic. Mr. Ritholtz is not alone in his suspicions. "I definitely think there is a link," said Byron R. Wien, chief investment strategist at Pequot Capital Management and a 40-year Wall Street veteran. "This precipitous unwinding created the negative momentum that spread around the world."

Mr. Wien also singled out the Federal Reserve chairman, Ben S. Bernanke, for criticism. "Bernanke has been reacting to events, rather than anticipating them," he said. On Monday afternoon, with United States markets closed for Martin Luther King’s Birthday, Mr. Ritholtz said, many Wall Streeters were struggling to figure out just why Europe and Asian markets were off so steeply. "Instant messages were lighting up, and people were saying ‘This looks like a big European hedge fund blew up.’ " Indeed, there was little market-moving data before the plunge.

He was quick to add that the French bank’s rapid turnover of the positions assembled by Mr. Kerviel would not have been enough to push the German market down 7.2 percent Monday. But in today’s fast-paced markets, hedge funds and investment firms often pile on once the selling starts. "These things take on a momentum of their own," he said. On Tuesday, the volume on the DAX and Euro Stoxx 50 contracts was twice that of open futures contracts, suggesting that the bank was having to sell and then buy back contracts to cover leveraged positions. Ten percent of the volume on DAX futures on Tuesday alone was 9.2 billion euros.

On a typical day, the total open interest on the Dax futures market is roughly $50 billion, according to Hélyette Geman, a professor of mathematical finance at ESSEC business school in Paris. Although the exact positions are not known at this moment, she said, it was quite likely that Société Générale’s trades would have accounted for a major portion of DAX futures activity in recent weeks. She added that settling those positions might have created some downward pressure in the market.

A Société Générale trader said that Mr. Kerviel, a member of Société Générale’s Delta One team, frequently worked late into the night after other members of the group had gone home. He added that it appeared the pace of Mr. Kerviel’s trading picked up toward the close of 2007. Many of the trades were placed on near-term futures contracts, the trader said. Jean-Pierre Mustier, chief executive of Société Générale’s corporate and investment banking division, declined to identify which particular indexes formed the bulk of the specious trades, but insisted during an interview that closing the positions early in the week did not cause the steep plunge in markets across Europe.

Meanwhile, the legal noose appeared to tighten around Mr. Kerviel, as French police raided his apartment in the suburban Paris neighborhood of Neuilly-sur-Seine Friday evening. A spokeswoman for the Paris prosecutor’s office, which on Friday opened a preliminary investigation into the case, declined to comment on the raid. "An investigation is under way," said the spokeswoman, Isabelle Montagne. "We must let the police do their work." At the same time, French government authorities signaled growing frustration with Société Générale.

Indeed, Paris appeared to be putting pressure on Société Générale to come forward with a more detailed accounting of how Mr. Kerviel could have racked up the staggering losses by himself over the course of a year without raising any red flags among either his supervisors or the internal auditors of the bank. François Fillon, the French prime minister, expressed frustration Friday at having been kept in the dark about the unfolding crisis until Wednesday— four days after Société Générale’s chief executive, Daniel Bouton, informed the governor of the country’s central bank, Christian Noyer.

Speaking to reporters at a briefing in Luxembourg, Mr. Fillon conceded that as a private bank, Société Générale was not obliged to inform the French government. He said, however: "It’s an affair of such an importance for the French financial system, that maybe the government could have been informed earlier." Mr. Fillon said that he had asked the finance minister, Christine Lagarde, to conduct a separate inquiry into the affair and report back to him within eight days. A spokesman for Ms. Lagarde could not be reached for comment.

The bank, meanwhile, identified four other individuals, in addition to Mr. Kerviel, who had been dismissed in connection with the scandal and would face disciplinary action: Marc Breillout and Grégoire Varenne, co-heads of fixed-income trading; Christophe Mianné, global head of market activities; and Luc François, global head of equities and derivatives activities.



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