French Bank Links Lone Futures Trader To $7 Billion Fraud

Banking specialists said Societe Generale's first misstep was catapulting an employee armed with the back-office secrets of the bank's internal security monitoring system into the aggressive role of a futures trader.

Kerviel, who banking officials said was paid just under $146,500 a year in salary and bonuses, was tasked with trading in European equities futures, a speculative market that involves betting on the future performance of stocks.

The trader maintained two sets of books, one in which he kept accounts of his successful investments, and a secret parallel book where he was "voiding his losing positions," Bouton said.

"He knew when controls were going to take place," Bouton said, because "over the years he had become an expert in controls." Bouton said Kerviel managed to outmaneuver six levels of controls and firewalls intended to detect and prevent fraud.

Kerviel "made a mistake in December which triggered our controllers," Bouton said. But for reasons that remain undisclosed, bank officials did not discover the fraud until last Friday night, when markets began a precipitous slide and the losses in some of his speculative trades became more obvious.

Societe Generale officials hauled Kerviel into the office for a six-hour interrogation on Saturday. By Bouton's account, the trader confessed to cooking the books to hide unauthorized trades. "His motivations were totally incomprehensible," Bouton said. "It does not seem that he would have profited directly from this gigantic fraud."

Bank officials spent last weekend and the early part of this week secretly selling many of Kerviel's investments to try to mitigate the damage. But the worst collapse in world stock markets since the Sept. 11, 2001, terrorist attacks drove Kerviel's losses higher and higher, eventually topping $7 billion.

"These losses could have been gains if the market had climbed on Monday, Tuesday and Wednesday," Bouton told reporters.

Noyer of the Bank of France said that Societe Generale notified banking regulators of its investigation last weekend, before beginning its sales. But the Fed source said the U.S. central bank remained unaware of it on Monday, as markets abroad took their deep plunges. U.S. markets were closed for the Martin Luther King Jr. holiday.

"It does appear that the move to unwind those positions contributed to the stunning decline in stocks at the beginning of the week," said Louis Crandall, chief economist at Wrightson ICAP, a bond market research firm. With U.S. markets closed, the price-depressing effects of sales in foreign markets would have been amplified, he observed.

"The Fed would have responded differently if the decline was because of a special situation rather than general systemic fragility," he said.

"The Fed was duped," said Axel Merk, manager of the Merk Hard Currency Fund. "It thought this was a widespread event. But it seems to have been just one trader." The big interest rate cut was not "the right reaction," he said.

Other analysts saw no connection. "The whole thing's incredible, but I don't think that's why the Fed cut rates," said David Kotok, chief investment officer at Cumberland Advisors. "I don't think Societe Generale had anything to do with the Fed's decision."

Following the French bank's news, the Fed remains comfortable that the rate cut was the right move and not a response to the bad day in the markets, the Fed source said, because it views the problems in world financial markets as symptomatic of emerging economic weakness.

Societe Generale had other bad news on Thursday for stockholders: It had suffered nearly $3 billion in losses from investments connected to the subprime mortgage crisis. It will seek an infusion of $8 billion of new capital, it said.

The Bank of France said it would launch an investigation of the alleged fraud. Shareholders from the United States, Germany, France, Belgium, Switzerland and the Netherlands filed lawsuits alleging fraud, breach of trust and receipt of stolen goods against Societe Generale, attorneys said.

Trading of the bank's stock, which has lost almost half of its value in the past six months, was suspended temporarily on the French stock exchange Thursday and financial ratings services downgraded the bank's ratings.

Staff writers Jeffrey H. Birnbaum and Neil Irwin in Washington and researcher Corinne Gavard in Paris contributed to this report.