Checks by SocGen missed $73bn bet
Paris, January 28, 2008
French bank Societe Generale has admitted that a gap in control systems allowed a junior trader to take a $73 billion losing bet on European share prices.
However, it defended its handling of the world's biggest trading scandal.
Prosecutors said the trader, 31-year-old Jerome Kerviel, would remain in custody until Monday after handing himself in on Saturday and was co-operating with a probe into how the bank racked up $7 billion losses on alleged illicit deals.
Kerviel's new lawyer said he had been doing a trader's job by taking on risk and accused the bank of setting him up for a public "lynching" by letting him carry all the blame.
"He has not embezzled anyone, he hasn't taken a cent for himself and he was just doing his job as best he could," Christian Charriere-Bournazel told Reuters.
Three days after stunning world finance with news that a lone, lowly trader had punched a hole in its compliance systems and forced the bank to seek a lifeline of new capital, SocGen set out in detail how it says he took dizzying risks undetected.
Like rogue trader Nick Leeson who sank Britain's Barings bank in 1995, the picture that emerged from Kerviel's employer on Sunday was of a young man trained by his own bank to detect fraud and then using these skills to work round controls as a trader.
Both tried to cover up for bad trading decisions by doubling their bets and waiting for the market to turn in their favour. The similarities do not end there. Both were involved in arbitrage -- taking advantage of price differences between markets -- on stock index futures and covered their tracks by juggling real deals against fake ones with fictitious people, according to the results of a forensic data search at SocGen.
The bank says it remains baffled as to why one of its more junior trading staff put his career and the bank at risk. "We don't know, we don't understand and it will be for the legal inquiry to find out," corporate and investment banking chief Jean-Pierre Mustier said.
Kerviel was paid to exploit tiny and momentary discrepancies in prices of very similar stock market instruments. To make money on this, the bank has to wager big volumes but the risk is usually small because each transaction is balanced with an equal and opposite one, locking in a tiny layer of profit.
The bank alleges its staffer created fictitious accounts to make it look as though his aggressive and ill-fated bets that European shares would rise had been covered. The bank remained unwittingly open to the risk prices would fall, and they did.
Although SocGen prides itself on state-of-the-art finance using mathematical models, its rogue trader was using "very simple instruments" as a vehicle for his deals, which he then hid using high-tech smoke and mirrors, according to Mustier.
He was able to get away with it partly because SocGen's risk systems do not check up on unregulated over-the-counter contracts straight away if no deposit is required, the bank said.
Furthermore, the bank primarily looks at the net exposure to market prices rather than the total outstanding amount wagered. Bank risk experts say this approach is not peculiar to SocGen.
Shares prices have fallen this year as markets fear a downturn in the US economy due to the global credit crunch. To keep the checks at bay and continue trading, the rogue dealer falsified documents and misappropriated passwords, SocGen said.
The anomalous trades only came to light on Jan. 18 and two days later managers informed the board they faced huge losses.
The shell-shocked bank also defended itself from accusations that its move to unwind the trade distorted the market and might have inadvertently triggered a cut in US interest rates.
"We were not the cause (of the slump), we had to submit to it," Mustier said. The positions were unwound by a single trader between Jan. 21 and Jan