Thursday, January 24, 2008

Societe Generale Reports EU4.9 Billion Trading Loss (Update8)

By Gregory Viscusi and Anne-Sylvaine Chassany

Jan. 24 (Bloomberg) -- Societe Generale SA said bets on stock index futures by a rogue trader caused a 4.9 billion-euro ($7.2 billion) trading loss, the largest in banking history.

Jerome Kerviel, 31, was the trader responsible, the Paris- based bank said today. Societe Generale plans to raise 5.5 billion euros from shareholders after the loss and subprime- related writedowns depleted capital. The Bank of France, the country's banking regulator, is investigating the alleged fraud.

The trading loss exceeds the $6.6 billion Amaranth Advisors LLC lost in 2006, and is more than four times the $1.4 billion of losses by Nick Leeson that brought down Barings Plc in 1995. An offer by Chairman Daniel Bouton to resign after the trades were discovered this past weekend was refused by Societe Generale's board, the bank said.

``At first this seemed like a joke,'' said Nicolas Rutsaert, an analyst covering European banks at Dexia SA in Brussels. Societe Generale ``was a leader in derivatives and was considered one of the best risk managers in the world.''

Societe Generale fell 3.27 euros, or 4.1 percent, to 75.81 euros in Paris trading, bringing declines this year to 23 percent and valuing the bank at 35.3 billion euros. The Dow Jones Stoxx 600 Index surged 5.2 percent today to 322.08, its biggest gain since March 2003.

Fake Trades

Societe Generale started unwinding the trading positions linked to European stock index futures on Jan. 21, a day when equity markets in France, Germany and the U.K. fell more than 5 percent. The next day the U.S. Federal Reserve cut interest rates by the most in 23 years as ``financial market conditions continued to deteriorate.''

``It's not possible that our covering operations contributed to the market's fall,'' said Philippe Collas, the head of asset management at the bank.

The trading loss wipes out almost two years of pretax profit at Societe Generale's investment-banking unit, run by Jean-Pierre Mustier. The company said it's suing the trader, who had a salary and bonus of less than 100,000 euros a year and worked at the bank since 2000.

Four to five people will be fired as a result of the loss, Mustier told reporters at a press conference in Paris. Luc Francois, the head of equity markets, is among those who will lose his job, said spokesman Hugues Le Bret. He declined to comment about Kerviel.

``The transactions that were built on the fraud were simple, positions linked to rising stock markets, but they were hidden through extremely sophisticated and varied techniques,'' Bouton, 67, said in a letter posted on the bank's Web site.

`In the Money'

His approach was to balance each real trade with a fictitious one, and his ``intimate and perverse'' knowledge of the bank's controls allowed him to avoid detection, co-Chief Executive Officer Philippe Citerne told reporters. He rolled over his real trades before they reached maturity.

By the end of December, he was ``massively in the money,'' said Collas. Since the beginning of the year his trades became unprofitable.

The trades first came to management's attention on the evening of Jan. 18, when a compliance officer found a trade that exceeded the bank's limits, Mustier said. When Societe Generale called the counterparty, they were told the trade didn't exist.

The employee, who moved to the trading floor from the back office in 2006, helped with the investigations throughout the weekend, said Mustier, who didn't identify the trader and said he doesn't know where he is now.

The trader didn't enrich himself from the fraudulent trades, which began in early 2007, and his motivations are unclear, Bouton said at the press conference.

`Breached' Controls

He ``breached five levels of controls,'' Christian Noyer, the governor of the Bank of France, said at a press conference today. He described the trader as ``a computer genius'' and said he was told he was ``on the run.''

Management des Operations de Marche, a business school in Lyon, lists Kerviel as a 2000 graduate.

Societe Generale joins a list of at least five financial firms since the start of the 1990s to suffer losses from unauthorized trades, including Kidder Peabody, Barings, and Allied Irish Banks Plc.

French President Nicolas Sarkozy wouldn't comment on the investigation beyond calling it ``fraud,'' said spokesman David Martinon. Foreign Minister Bernard Kouchner said in an interview at the World Economic Forum in Davos, Switzerland, that he is ``concerned'' about the case.

Takeover Target

The bank said it will post a profit of 600 million euros to 800 million euros for 2007 and pay a dividend equal to 45 percent of its earnings. ``Most of the sectors, in France and abroad, continue to produce good, and sometimes excellent results,'' Bouton said.

Bouton and Citerne won't receive bonuses or stock options for 2007, and will forgo their salaries for the first half of this year. Mustier won't receive a 2007 bonus or stock options.

The company said it plans to raise capital by selling shares in a rights offer underwritten by JPMorgan Chase & Co. and Morgan Stanley. Following the transaction, the bank's Tier 1 ratio, a measure of solvency, will rise to about 8 percent from 6.7 percent at the end of 2007.

Bouton, asked whether the affair made Societe Generale a more likely takeover or merger target, said ``we are not looking for this. Our goal is to have the bank working as well as possible after this incredible accident.''

Bouton said he wasn't seeking capital from sovereign funds, which have invested in banks including Citigroup Inc., Merrill Lynch & Co. and UBS AG in the past two months.

Rogue Traders

``It's a disaster,'' said Guy De Blonay, who helps manage about $41 billion at New Star Asset Management Group Plc in London. Still ``an acquirer could be tempted. You have got a superb franchise here at an attractive price.'' De Blonay said he had bought shares in the bank today.

Societe Generale, founded in 1864, has 120,000 employees in 77 countries and 22 million retail-banking clients, according to information on its Web site.

``Banks, despite the implementation of sophisticated risk management solutions, are still under the threat that an employee with a good understanding of the risk management processes can get round them to hide his losses,'' said Axel Pierron, a senior analyst at Celent, an international financial research firm.

Societe Generale has ranked first or second during the past five years in client surveys of equity derivative firms, according to Risk Magazine. In 2007, it received the award for ``Equity Derivatives House of the Year'' from The Banker, a London-based monthly magazine.

`Mr. Copper'

Societe Generale's report of fraud comes four months after French competitor Credit Agricole SA said an unauthorized proprietary trade at its investment-banking unit in New York cost it 250 million euros.

In 1994, Kidder Peabody, then owned by General Electric Co., took a $210 million charge against first-quarter earnings to reflect what it said were false profits recorded by bond trader Joseph Jett. The allegations and unrelated bond losses led GE to sell most of Kidder to Paine Webber in 1995. UBS AG bought Paine Webber in 2000.

Sumitomo Corp. disclosed a $2.6 billion loss in 1996 on copper trades. The Japanese firm blamed unauthorized trades by its chief copper trader, Yasuo Hamanaka, who was known as ``Mr. Copper'' in the markets because of his aggressive trading. Hamanaka was sentenced to eight years in prison in 1998.

Allied Irish

Allied Irish Banks Plc discovered in 2002 that John Rusnak, a trader at its Allfirst Financial Inc., had amassed and hidden $691 million of losses over more than five years before the company noticed any discrepancies. Rusnak was sentenced to 7 1/2 years in prison. Allied Irish sold the Baltimore-based unit to M&T Bank Corp.

Societe Generale said that it has already closed all the positions set up by the trader, who had used his experience working in the back office to hide his trades through fictitious transactions.

Societe Generale said it's taking 1.1 billion euros of writedowns linked to the U.S. residential real estate market, 550 million euros related to U.S. bond insurers, and 400 million euros on other unspecified risks.

In the third quarter, the bank reported 375 million euros of writedowns and trading losses linked to turmoil in financial markets. The world's biggest financial companies have announced more than $120 billion in writedowns and credit losses as the U.S. housing slump rattles debt markets.

No comments: