French Bank Links Lone Futures Trader To $7 Billion Fraud

By Molly Moore
Washington Post Foreign Service
Friday, January 25, 2008

PARIS, Jan. 24 -- For five years, Jérôme Kerviel toiled in the back offices of Societe Generale, learning the intricacies of the six-layer security system that France's second-largest bank used to protect its money, investors and customers from fraud, according to bank officials here.

Kerviel then made an unusual career move. He was promoted to trader -- becoming one of the very employees the security systems are designed to oversee and keep honest.

Over the next several months, his chagrined employer alleged Thursday, Kerviel used his inside knowledge of the security system and his brazenness as a futures trader to pull off one of the largest banking frauds in history, ringing up losses of more than $7 billion for Societe Generale.

The trader hid the massive fraud "using extremely sophisticated and varied techniques," Societe Generale Chairman Daniel Bouton told reporters Thursday. Bouton and other bank officials had little explanation for Kerviel's motivation, except to say he appeared to have acted alone and to have made no personal profit, instead creating losses through successive transactions of buying dear and selling cheap.

There was no comment Thursday from Kerviel, whom the bank said it had fired along with several of his supervisors. The man described as a 31-year-old computer genius dropped out of sight, but Elisabeth Meyer, his lawyer, said on French television that he "is not fleeing" and is "available for judicial authorities." She did not specify where he was; calls to a telephone number listed under his name went unanswered.

The disclosure of the losses was the latest shock to world financial markets as they struggle to recover from a massive sell-off earlier in the week linked to problems in the U.S. subprime mortgage market. Some analysts suggested that high-volume sales by Societe General on Monday as it secretly liquidated Kerviel's tainted investments contributed to the global market drops that led the U.S. Federal Reserve to counter Tuesday with an interest rate cut of three-quarters of a percentage point.

The Fed was unaware Monday that the bank was making its sales, according to a Fed source who spoke on condition of anonymity, leading some analysts to charge that the central bank overreacted in its rate cut. Investors in futures markets are now betting there is less likelihood that the Fed will make another steep rate cut at its regularly scheduled meeting next week.

The case highlighted global distrust of the financial institutions that hold personal nest eggs and corporate wealth, and the regulators charged with keeping them honest. The Bank of France, the country's banking regulator, conducted 17 investigations at Societe Generale during 2006 and 2007, but spotted no evidence of fraudulent activity, its chief reported Thursday.

"I don't consider this a failure of our controls," Christian Noyer, governor of the Bank of France, told reporters. "We can't have a controller behind every trader at every bank in the country at every moment. Even the best laws and the best police can't always stop someone who is determined to defraud the system."

But analysts and banking experts said the statements by both institutions revealed troubling failures in oversight. "What guarantees do we have that this cannot happen again tomorrow with another trader?" asked Xavier Timbeau, director of analysis and forecasting at the French Economic Observatory. "None."

If confirmed, the losses at the bank would be the largest ever caused by an individual trader. They are far higher than the $1.4 billion run up by trader Nick Leeson in the mid-1990s in Singapore. His fraud caused the collapse of the institution where he worked, Britain's 233-year-old Barings Bank.

Leeson, now living in Ireland after serving a prison sentence in Singapore, told the BBC that he was not shocked such a fraud had happened again, but that "the thing that really shocked me was the size of it."

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.

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