Master fraud or fall guy?

27 January 2008

A top French economist warns that Societe Generale could use the debacle to cover up bad investments, writes Thomas Hubert in Paris.

Stand back John Rusnak and Nick Leeson, enter Jerome Kerviel. According to Societe Generale, the 31year-old French trader is the sole culprit in the €4.9 billion fraud that will wipe out the equivalent of one year’s profit at France’s number three bank.

Societe Generale announced last Thursday that a single employee, which it later named as Kerviel, had run up losses worth nearly €5 billion. On the same day, the bank announced another €2 billion loss linked to the sub-prime crisis.


He had previously held a middle-office position at the bank, working on the safety procedures used to control traders. According to the bank, he used his knowledge of the procedures and the schedule of routine checks to avoid them.

Kerviel’s job only involved limited futures trading to counterbalance some of the risks taken by his colleagues working on the shares market - so-called plain vanilla trading. Yet the bank admitted that he managed to go far beyond his remit in late 2007 and early 2008,hiding the volume of money involved behind fake transactions.

An embarrassed SocGen executive chairman Daniel Bouton said at a press conference at his group’s headquarters in Paris last Thursday: ‘‘In the official Societe Generale book he registered transactions that went unnoticed, because at the same time he carried out other transactions that nullified earlier ones.

‘‘The transactions used for dissimulation purposes were fictitious, and he had the extraordinary talent of moving them along as checks happened because he knew the controls’ schedule.”

The bank said in a statement that it caught the trader when he made an error that appeared in a routine verification.

‘‘His motivation is totally incomprehensible. He does not seem to have benefited personally from the fraud,” Bouton said.

Since it discovered the scam last Sunday, Societe Generale has been busy cleaning up the mess. It started by secretly dumping the futures contracted by the trader during the first half of the week. Dreadful market conditions at the time explain the staggering volume of the losses incurred. The bank was nursing losses of more than €1 billion when it discovered the fraud, but lost a multiple of this by selling tens of billions of euros of contracts into a falling market.

Bouton handed in his resignation, but the bank’s board refused to accept it. However he said the trader and his chain of command, up to and including the group’s head of share dealing, Luc Francois, had been fired.

The Paris stock exchange suspended trading on Societe Generale shares all Thursday morning, while the bank’s management was holding a press conference.

Bouton and Citerne seemed to convince investors that they could deal with the crisis, as the group’s share fell by only 4.14per cent in the afternoon. However, this comes after 10months of near-continuous fall. After hitting an all-time high of €162.79 last April, Societe Generale shares were worth just €75.81Thursday evening.

The lone fraudster theory did not convince all commentators. Top French economist and equity expert Marc Touati said: ‘‘You can imagine fraud over a few hundred millions, but not €5 billion. If someone could run such a scam, it would mean that there are serious governance problems at Societe Generale, which I do not believe. There have been heavy losses on sub-primes or somewhere else, and the impact of the fraud might have been exaggerated.”

In other words, the bank could be tempted to saddle Kerviel with the burden of some of the bad investments it made in recent months.

The fraud scandal could not have come at a worse time for Societe Generale, France’s second-biggest bank. The company had to announce further write-downs of €2billion linked to the global credit crunch and said it would raise €5.5 billion through a shares issue to strengthen its balance sheet.

The losses cut its 2007 profit to between €600 million and €800 million from €5.2billion in 2006. The bank’s shares have fallen by 50 per cent in the last six months.

There is speculation that it could now be the subject of a takeover bid, having received a number of approaches in the last few years. The most recent came last April when it was linked to a bid from banking giant Unicredit.

Societe Generale is one of France’s biggest companies and is a household name, with a significant retail bank branch network. Founded in 1864, it has €467 billion in assets under management and 22.5 million customers worldwide. It employs 120,000 staff in 77 countries.

Its Irish operations through Societe Generale Finance (Ireland) had retained profits of €22 million at the end of 2006.