French banking group Société Générale has uncovered a $714 billion fraud, by a single futures trader identified as Jérome Kerviel (right) that came undone by roiling markets this week.
It could have been the plot of a thriller: A young lone trader secretly concocts bogus transactions for months, in an attempt to cover his spiraling losses, until he has siphoned off billions of euros from under the noses of one of France's most venerable institutions. For Société Générale — France's second-biggest bank — the details were all too real, however, as stunned executives attempted to explain on Thursday how a mid-level employee lost 4.9 billion euros ($7.2 billion) in a rogue operation without anyone noticing.
In what could be one of the biggest inside frauds in banking history, French futures trader Jérome Kerviel, 31, effectively created his own trading firm within the bank's market rooms, according to Société Générale CEO Daniel Bouton. "He succeeded in building this hidden firm, in building his positions by hiding them by other positions that were totally fictional," Bouton told reporters at a Paris news conference on Thursday. "That is what is so extraordinary about this case." Bouton's offer to resign was rejected by the bank's administrators this week. Bank official said Thursday they needed to raise $8 billion to cover their losses and that 2007 profits would likely be between 600 million to 800 million euros (about $874 million to $1.16 million), a sharp drop from its 2006 profits of about 5.2 billion euros.
Kerviel's identity was revealed on the Financial Times and Daily Telegraph websites, but was not confirmed by bank officials, who admitted on Thursday that the rogue trader appeared to have gone to ground and that they had no idea where he was. Executives said two years ago, the trader had a back-office job in the bank working on internal controls to prevent questionable and suspicious trades. He then transferred to a position trading in so-called "plain vanilla" stock futures in European markets. He earned a salary of about 100,000 euros (about $147,000). In his new job, he began trading far beyond his responsibilities, racking up debts as global markets gyrated. To cover his losses, he created complex fictitious trades, until the losses appeared to spiral out of control. Said Kinner Lakhani, a London-based analyst for the Dutch bank ABN Amro, who covers Société Générale: "It was out of the realms of anyone's expectation."
Bank executives said they finally realized their mammoth problem last weekend. Société Générale chief executive of corporate and investment banking Jean-Pierre Mustier told reporters that he was "convinced [Kerviel] acted alone." Kerviel confessed to the elaborate fraud during a six-hour grilling by bank officials on Saturday night, according to the Daily Telegraph, which posted a photograph online of a slender, dark-haired man. Despite the weekend revelations, three days lapsed before executives suspended trading of Société Générale shares. They declined to tell reporters at Thursday's press conference why the trader had not been immediately fired, nor why they had not involved the French police.
Executives said the trader was able to use his extensive knowledge of the bank's controls from his previous job at the bank in order to bypass the control system and create his own rogue operation. That revealed a crucial hole in the bank's security, says Mark Thomas, an analyst with Keefe, Bruyette & Woods in London. "The single most important factor [in security] is that the risk-control function is independent of traders," Thomas told TIME on Thursday. "You would typically put extra supervision on that person for a couple of years." Said ABN Amro's Lakhani: "This was management's biggest nightmare."
The huge scale and complexity of Kerviel's fraud has strong echoes of Nick Leeson, a young rogue British trader in Singapore. Leeson bankrupted the 230-year-old Barings Bank in 1995, after losing $1.38 billion in fictitious trades on Asian futures markets, single-handedly wiping out Barings' cash reserves. Leeson was jailed for more than three years in Singapore, and the scandal became almost synonymous with the power of a lone employee to unravel a large company. At the time, officials at various banks said they were tightening internal security measures in order to avert a similar disaster.
More than a decade later, those assurances sound thin to some analysts. "This raises huge questions marks about whether you can fix the rogue-trader risk," says Pierre Flabbee, head of banking-sector research for Landsbanki Kepler in Paris. "This demonstrates that you cannot. The human factor is one you cannot control 100 percent. The more sophisticated procedures become, the more sophisticated employers become."
Judging by Leeson's experience, Société Générale's rogue trader might some day land another career. Leeson is now manager of the Galway United soccer team in Ireland, and was portrayed by Ewan McGregor in the 1999 movie Rogue Trader, the film version of his autobiography. He has written a further book entitled Back from the Brink: Coping with Stress. That sounds like perfect bedtime reading this week for Société Générale executives.