SocGen uncovers €5bn fraud
By Martin Arnold in London and Peter Thal Larsen in Davos

Published: January 24 2008 07:19 | Last updated: January 24 2008 10:23

Société Générale said on Thursday it had discovered €7bn of losses from a rogue trader in European stock futures and big US subprime mortgage writedowns, forcing the French bank into an emergency €5.5bn share issue.

Daniel Bouton, the long-standing chief executive and chairman of SG, offered to resign, but this was rejected by the board after reviewing the colossal losses – including €2.05bn of writedowns on exposure to US mortgages and bond insurers.

EDITOR’S CHOICE
SocGen press release - Jan-24FT Alphaville: Live from SG conference call - Jan-24European view: European bank consolidation - Jan-21John Gapper: Human lesson of Nick Leeson's fraud - Feb-16Moody’s backs SocGen investment - Dec-21SocGen cuts value of assets by €404m - Nov-08The announcement is a massive blow for fragile investor confidence in the banking sector, which is already reeling from multi-billion dollar writedowns at many of the biggest investment banks on Wall Street and the City of London.

It also raises serious questions about banks’ risk-management procedures and their ability to control their own trading positions. One analyst said: "This news will cast a dark cloud over the already troubled European banking sector."

SG said the “exceptional fraud” by its unnamed rogue trader resulted from the purchase of huge long positions in “vanilla futures hedging on European equity market indices” that were “beyond his limited authority”.

The rogue trader – likely to trigger comparisons with the UK’s Nick Leeson, who caused the collapse of Barings Bank in 1995 – had “deep knowledge” of risk-control procedures from his time at the bank’s middle-office activities, which SG said had allowed him to conceal his positions.

The bank said it had no more exposure to the rogue trader’s positions which were identified and analysed on January 19 and 20 and then unwound just as stock markets crashed unexpectedly around the world on January 21.

“The decision was made to unwind this position this position was taken because it was impossible for the bank to maintain,” said Mr Bouton.

It refused to give any personal details of the man, who it said had confessed and been suspended pending a dismissal procedure. Mr Bouton said the trader had switched from short positions in 2007 to long positions at the start of this year “for reasons we did not understand”.

The losses are a heavy setback for SG, which had previously told investors that it had “very limited exposure” to the turmoil in debt markets caused by the crisis in US subprime mortgages.

They could trigger fresh speculation about a possible takeover of SG, which was already a perennial candidate for consolidation in the European banking sector. Mr Bouton said it would announce a strategic review next month.

SG said it would take €1.1bn of writedowns on its exposure to the US residential real estate market, €550m of losses linked to US bond insurers, and €400m on other unspecified credit market risks. It had already reported €375m of writedowns linked to the credit market turmoil in the third quarter.

The bank said it expected to make a profit of €600m-€800m for 2007 – a fraction of its €5.2bn earnings the previous year. Its corporate and investment banking unit would make a loss of €2.3bn.

Its plan to raise €5.5bn – to be underwritten by JP Morgan and Morgan Stanley – contrasts with the trend for US banks to raise capital from sovereign wealth funds in the Middle East or Asia. Mr Bouton said French and foreign investors had already contacted him to express interest in taking part in the share issue.

The SG boss said the rogue trader’s loss had been exaggerated by difficult market conditions this week. But he defended the bank’s risk-management processes. “All our models of stress-testing work perfectly well,” he said.

Jean-Pierre Mustier, head of investment banking who had been seen as a potential successor to Mr Bouton, said the position occupied by the rogue trader was only expected to generate €20m of revenue a year. “The specific pattern of his transactions was that they used fake transactions rolled on a permanent basis,” said Mr Mustier.

SG said the €5.5bn capital increase would increase its tier one ratio – a measure of capital adequacy used by regulators to monitor solidity of banks – to 8 per cent after its planned acquisition of Rosbank in Russia.