Unraveling of the SocGen Fraud
The news about a massive securities fraud by a rogue trader at France’s second largest bank, Société Générale, just keeps getting worse. The Financial Times reported on Tuesday that the bank didn’t lose the $4.9 billion euros that it first reported, but will actually report losses of over $6 billion euros after unwinding the unhedged bets by the rogue trader, Jérôme Kerviel. In what may be one of the great understatements of the year, CEO Daniel Bouton stated that the internal audit system of the bank’s risk management is insufficient to prevent this type of fraud.
President Sarkozy of France, who has been in the papers more than Britney Spears lately on affairs both private and public, has made it clear that he wants heads to roll. But who should ultimately be accountable for the biggest scandal to hit the financial markets since the downfall of Barings bank in 1995? There seems to be three upfront players in this blame game and all three seem to have played a little fast and loose with the numbers.
First and foremost, we have the 31-year-old rogue trader, who has become an overnight cultural icon, thanks to the internet. Jérôme Kerviel accomplished what only movie stars have done before him. Blogs on both sides of the Atlantic are buzzing about his background and motivation. In the mainstream media and the blogosphere, he is alternately cursed and commended. The social networking site Facebook has even formed a group nominating him for the Nobel Peace Prize. His supporters believe he did everything from exposing the corrupt corporate lifestyle of the European investment banks to saving the U.S. markets from a recession. But most financial analysts believe that he single-handedly touched off a global market decline and erased billions of dollars of value from the European stock market.
It seems that those who support his actions forget that Kerviel admitted to faking trades and forging documents, not to mention defrauding his employer out of billions of euros for his own personal financial gain. While part of the blame must be placed on the rogue trader himself, should he share some of that infamy with his supervisors?
Jean-Pierre Mustier, the head of corporate and investment banking at SocGen, has described his employee as “having a spunk to him.” According to the Financial Times, Mustier says that the banks internal risk management system failed to cross check alerts. It has been reported in the Wall Street Journal Online as well that the company’s infrastructure contributed to blind spots detecting errors; because each department was viewed separately. Mustier admits that Jérôme Kerviel’s knowledge of the back office and the insufficiencies of the system helped him hide trades through fake hedges in different sectors.
Indeed, technology exists that could have prevented this sort of catastrophe. Complex Event Processing (CEP) platforms allow companies to keep pace with information flowing through their system. The platform detects patterns and sets off warning signals that this sort of unusual activity is taking place. The question remains, even with this technical advantage, could something have been done in time to halt or minimize losses?
Mustier and the bank were notified by Eurex, the European derivatives exchange, of the suspicious trading activity back in November 2007. In fact, according to the Wall Street Journal Online, Eurex raised red flags about SocGen’s trading activity twice and both times the comments were swept under the rug.
Also, Jérôme Kerviel admits that while he tried hiding the rogue activity, there were tell-tale signs that something was wrong. Kerviel never took vacation and was extremely secretive about his work, never letting anyone take a peek at his screen to see his positions. Did Mustier not see the writing on the wall?
The third character in this story is Daniel Bouton, Chairman and Chief Executive Officer of Société Générale. Bouton, who joined the bank in 2000, has had troubles from the start. SocGen had been aligned to acquire their competition, the independent bank Paribas. According to the Financial Times, BNP swept in with a hostile bid, stole Paribas and almost got their hands on SocGen as well. It is thus ironic that BNP Paribas is now the leading contender to acquire the equity derivatives powerhouse.
While Bouton gave his resignation after the fraud had been announced, the board wanted him to stay put until the bank was out of danger. He went to work raising $5.5 billion in capital through an emergency rights initiative and was gaining momentum, until he was summoned to court. Bouton is defending himself, not from charges stemming from the SocGen fraud, but from a money laundering scandal that involves foreign currencies and three other banks. This could not have come at a worse time for the chairman and CEO of Société Générale. Indeed, European corporate governance experts take a dim view of the same executive serving as chairman of the board and chief executive officer, on the theory that it creates conflicts diminishes oversight at the top.
It seems as if Société Générale is cracking under the pressure. Speculations are spinning as to why the bank waited until after they unwound their positions before reporting the fraud to authorities. The initial loss was also more than the company reported at the time. We have a young rogue trader not playing by the rules, a questionable head of department and a suspect chief executive officer. All the players, suspicions and updated news releases dig SocGen into a deeper hole. So I ask the questions; who should be held accountable and for what? Losing 6 billion euros or exposing a central bank’s failures of corporate governance?
