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Société Générale loses $7 billion in trading fraud

PARIS — Société Générale, one of the largest banks in Europe, was thrown into turmoil Thursday after it revealed that a rogue employee had executed a series of "elaborate, fictitious transactions" that cost the company more than $7 billion, the biggest loss ever recorded in the financial industry by a single trader.

Daniel Bouton, the Société Générale chairman, said the employee, later identified by other bank employees as Jérôme Kerviel, had confessed to the €4.9 billion fraud, although he did not appear to have profited personally from the trades. The bank has started legal proceedings against the employee, whom the governor of the Bank of France, Christian Noyer, said was currently "on the run."

Later, a woman identified as the trader's lawyer, Elisabeth Meyer, said on French television that he was "not fleeing" and was "available for judicial authorities." She did not say where he was.

Before the discovery of the fraud, Société Générale had been preparing to announce pretax profit for 2007 of €5.5 billion, a figure that Bouton said would have shown the company's "capacity to absorb a very grave crisis."

Instead, Bouton - who is forgoing his salary through June as a sign of taking responsibility - said the "unprecedented" magnitude of the loss had prompted it to seek about €5.5 billion in new capital to shore up its finances, a move that secures the bank against collapse.

Société Générale also said Thursday that it would write off €2.05 billion of U.S. exposure in the fourth quarter, including €1.1 billion related to the housing market and €550 million related to U.S. bond insurance companies. It said it was setting aside an additional €400 million in provisions against the risk that those losses would grow.

The situation drew comparisons with Nick Leeson, the trader in Singapore who in 1995 incurred a loss of $1.4 billion by making $27 billion of bad bets on Japanese markets, bringing down the venerable British bank Barings in the process. It also raised questions about how losses of this nature could go totally unidentified amid the network of risk management in place at a major bank like Société Générale.

Société Générale said it had no indication whatsoever that the trader - who joined the company in 2000 and worked for several years in the bank's French risk-mangement office before being moved to its Delta One trading desk in Paris - "had taken massive fraudulent directional positions in 2007 and 2008 far beyond his limited authority."

The bank added: "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 trader - whom Noyer said "breached five levels of controls," and was "a computer genius" - continued the fraud until this past weekend, when auditors in the company's risk-management office detected a series of fictitious trades on its books, which it said was committed by an employee in charge of hedging the bank's trades in European stock index futures.

When the fraud was unveiled, Bouton said, it was "imperative that the enormous position that he had built, and hidden, be closed out as rapidly as possible."

The timing could hardly have been worse. Société Générale was forced to begin unwinding the trades on Monday "under conditions of extreme market volatility," Bouton said, as global stock markets plunged amid mounting fears of an economic recession in the United States.

The company closed out its remaining exposure to the trades on Tuesday as markets whip-sawed following the surprise decision by the U.S. Federal Reserve to slash its benchmark interest rate by three quarters of a percentage point.

"The result was a considerable loss," Bouton said.

Kerviel, who reportedly earned less than €100,000 a year, could not be reached for comment.

Société Générale said the trader was no longer working for the bank and that four other individuals - including the head of the bank's global equity and derivatives trading division, Luc François - had been dismissed. As of late Thursday, the bank had not filed any criminal complaints, said Isabelle Montagne, a spokeswoman for the Paris prosecutors office.

"Given that the decision was taken over a weekend, they were faced with the worst possible market conditions on Monday and Tuesday," said Janine Gow, a French bank analyst at Fitch Ratings in Paris. "The fact that the sums are so large gives an indication of just how leveraged everything is today and how volatile equity positions are."

The bombshell for Société Générale comes at a time when the mounting losses from subprime-related investments have raised questions about risk-control management at many institutions.

Howard Lutnick, chief executive officer of Cantor Fitzgerald, said that if one trader had managed to undertake fraud on this scale it revealed a bigger weakness.

"One person could engineer it - but how could one person finance it?" Lutnick said on the sidelines of the World Economic Forum in Davos, Switzerland. "The question for the risk management department is: how was this kind of fraud financed? Where did that money come from?"

Howard Davies, the former chairman of the Financial Services Authority of Britain who is now director of the London School of Economics, said Société Générale's explanation of events seemed incomplete.

"I don't think we've had the full story," Davies said, arguing that one person, however well informed on the bank's control procedures, should not be able to hide a trade of this scale.

"It's a lot of money. Normally you have a compliance mechanism" that involves a trade like this to be run by more than one person to avoid a situation where it is "only one pair of eyes."

Others, however, were hesitant to rush to find fault with management at Société Générale, arguing that no risk-management control systems provide iron-clad insurance against a trader intent on breaking the rules.

"It's a great idea to have a stop sign, bit it only works if people obey it," said Heinz Reihl, a retired Citibank executive and expert on financial-risk management. "An event like this does not reflect on the quality of the bank as a whole. It is basically a problem of one department."

In a letter to Société Générale clients, Bouton - whose offer to resign was rejected by the Société Générale board - described the rogue trader as "an imprudent employee in the corporate and investment banking division."

He said the trader's supervisors were being fired and that controls had "been revised and reinforced to avoid any reoccurrence of further similar risk."

He also sought to reassure customers that they would not suffer from the loss, saying the capital increase was "fully guaranteed, and would offset the loss generated by the fraud."

The bank will raise €5.5 billion via a rights issue of preferred shares to investors, underwritten by JPMorgan Chase and Morgan Stanley. The rights issue, the bank said, would bring its Tier 1 capital ratio to 8 percent.

The scandal has the potential to be the largest trading fraud ever. Crédit Agricole, a French rival, said in September that it would have to take a €250 million charge related to an unauthorized trading position.

Julia Werdigier contributed reporting from London. Matthew Saltmarsh contributed from Paris. James Kanter contributed from Brussels and Katrin Bennhold from Davos, Switzerland.

Fed was unaware of bank loss

Federal Reserve policy makers did not know about the loss at Société Générale prior to their decision this week to lower interest rates, Bloomberg News reported from Washington.

Policy makers were convinced by late December that increasing volatility in financial markets reflected a weakening U.S. economy and that further rate reductions were needed, an official said on condition of anonymity.

"Legitimately, one could say they moved not because they were panicked about the stock market but because it was telling them important things about the macroeconomy," said Peter Kretzmer, senior economist at Bank of America Securities in New York.

Fed officials considered the rate change prior to the opening on Tuesday of the New York Stock Exchange, and decided that the benefits outweighed the costs of waiting. They remain comfortable with that decision, the official said.

A version of this article appears in print on   in The International Herald Tribune. Order Reprints | Today’s Paper | Subscribe

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