SocGen loss reveals dangers
Zurich, January 25, 2008
French bank Societe Generale's 4.9 billion euro ($7.1 billion) loss, blamed on a single employee, is a stark reminder that rogue traders can elude the most sophisticated security systems until it is too late.
Many other banks could be exposed, no matter how much they have invested in security dragnets and advanced fail-safe procedures, and fraudulent losses are likely to grow in size.
"Banks are making a lot more money and taking much bigger trading positions, so you can expect the size of scandals to get bigger," said Simon Maughan at MF Global.
The CEO and chairman of Lehman, Richard Fuld, told Reuters at the annual gathering of the World Economic Forum in Davos that the loss uncovered at SocGen was "everyone's worst nightmare" -- tacit admission that no bank should consider itself entirely immune from such a calamity.
SocGen's trader -- who like Nick Leeson, the rogue trader who brought down British bank Barings in 1995, made investments by betting on the future direction of stock market indexes -- appears to have gone undetected because of intimate knowledge of his employer's risk-control systems.
Sources at Societe Generale, who declined to be named, later identified the trader as Jerome Kerviel. The company had earlier described him as a junior trader in his thirties who had joined the bank in 2002.
"Somebody with in-depth knowledge of how to do something has the power to break those systems," said Janine Dow, senior director in Fitch's financial institutions group.
Nearly 13 years after Leeson ran up a $1.4 billion loss with bets on Tokyo's stock exchange index, SocGen was sent reeling by a similar tale of bad trades blowing up in the face of a dealer able to cover his tracks until he got found out.
SocGen said insider knowledge acquired by the trader in a previous position at the bank "allowed him to conceal his positions thanks to an elaborate assembly of fictitious transactions".
Risk-control techniques are based on past experience, which is one reason why they can never be entirely effective at catching fraud in the future, as technology quickly evolves and trading systems grow in sophistication.
Many bankers were astonished, but few were in any mood to crow over the French bank's misfortune. An emergency injection of capital will keep SocGen's banking activities ticking over.
Employees at Societe Generale said they were shell-shocked by the news and could scarcely believe that systems designed to prevent such disasters had been found wanting.
"We have a hyper-sophisticated system of checks and controls. It's very hard to understand," said a senior employee at the bank who asked not to be identified. "But there are always holes in any system."
One security expert said he thought it was unusual that someone with up-to-date knowledge of risk-control systems should have then gone straight into a job involved in trading, as appears to have been the case at SocGen.
"It sounds like an unusual combination of skills to have. Knowledge of anything is a powerful thing in the wrong hands, and if you know what the security controls are, it makes circumventing them easier," said a London-based consultant in security systems with a professional services company.
The consultant asked not to be identified, as his employer included SocGen among its clients.
Since the Leeson affair and other recent cases of fraud, security specialists have rushed to tighten up their systems and update their techniques, but staying ahead of the game is challenging.
"A motivated individual that understands security will go to where the controls are weakest, not where they are strongest," said the consultant.
US Treasury Secretary Henry Paulson, when he was chairman at Wall Street powerhouse Goldman Sachs, said fraud could never be eliminated because big banks were the size of small t