$Stock*Shop*Charts*News*Option$

[Stock Lobster]

G&M: Leeson fraud now looks like small change

ERIC REGULY
Globe and Mail Update
January 24, 2008 at 12:58 PM EST

ROME — You could almost hear the glee spewing from London's bankers and traders.

Move aside Nick Leeson and Barings; France, the country they love to hate even if it makes decent cheese, is now responsible for the biggest bank fraud in history. Société Générale Thursday revealed a rogue trader piled up €4.9-billion ($7.1-billion) in losses.

This, of course, is bad news for Mr. Leeson, the trader who had dug a $1.4-billion hole in Barings' trading account by the time he fled the British bank's Singapore office in 1995. Since completing his four-year prison sentence, young Nick has made a living giving talks on the rubber-chicken circuit.

But who wants to listen to him now? His French counterpart, identified as Jerome Kerviel, 31, will have a better story to tell. How much could he charge to tell how the French fried the country's second-biggest bank, making Mr. Leeson's trades look like pocket change in the process?

It's too early to tell whether SocGen, as it is known, will suffer the same fate as Barings. Probably not, is the answer. At the same time it disclosed the toxic trades, which came on top of €2-billion in losses related to credit exposure to the U.S. mortgage market, SocGen announced it is raising €5.5-billion in new capital.

“The capital increase is fully guaranteed, and will offset the loss generated by the fraud,” chairman and chief executive officer Daniel Bouton said in a letter to the bank's 22.5 million customers. “Société Générale's capacity to bounce back and renew with the profitable growth that has characterized the bank for many years remains intact.”

Perhaps, but there is no doubt the bank's financial health has taken a big hit. Even before the fraud was discovered, the rumours said SocGen is more likely to be victim than victor as the European banks merge into a small number of supergiants. French bank industry leader BNP Paribas is one oft-mentioned potential buyer. Another is UniCredit, Italy's biggest bank.

The bigger hit is to SocGen's reputation, which means heads are bound to roll. The rogue trader and his bosses have already been sacked. Mr. Bouton offered his resignation on Wednesday, but the board talked him out of it.

Who knows how long he'll last. Until l'enfant terrible mucked things up, SocGen had a stellar reputation in the derivatives game. Recently both Risk Magazine and another magazine called The Banker lauded it with equity-derivatives-house of the year awards.

What must be doubly embarrassing to SocGen was the fact that Mr. Kerviel wasn't doing anything exotic in the derivatives market. By the bank's own admission, he was responsible for “plain-vanilla futures hedging” on European market indexes, such as the DAX in Frankfurt and the CAC in Paris. This meant he was employed to protect the bank's equity exposure through the use of index derivatives. Think of it as an insurance policy against equity losses. This sort of hedging is standard industry practice.

The problem, it appears, is that hedge boy wasn't just hedging. SocGen says he took “directional positions” last year and into January that went “beyond his limited authority.” When the losses piled up he, like Nick Leeson, concealed them. The bank said he drew from his in-depth knowledge of control procedures to hide the losses through a “scheme of elaborate fictitious transactions.”

The fraud was uncovered last week and the positions were unwound. SocGen executives called the trades “inexplicable” and said Mr. Kerviel, who has admitted to the cover-up, did not personally profit from the fraud. There were no other details.

What is astounding is the amount of money he would have had to invest to pile up losses of €4.9-billion. European indexes are down 15 per cent, give or take a couple of points, since the late autumn. This implies the face value of his positions must have been €30-billion or more. How could a single, young bank employee have built enormous positions without the risk gnomes knowing about it? The answer is obvious: There are serious flaws in SocGen's oversight and risk-management departments.

SocGen investors took the fraudulent trading losses and writedowns in stride. SocGen shares fell a mere 3.6 per cent, to €76.23, suggesting shareholders think the capital-raising exercise is enough to repair most of the damage. SocGen's woes did not spread to the rest of the market. The European indexes surged Thursday.

The story of the rogue trader could be a one-day wonder. Or it could be the opening salvo in a barrage of bad news. Official investigations are under way and could turn up some ugly information about SocGen's risk-management systems, or lack thereof. Executives could get fired and investor confidence in the bank's senior management could wane. Even before Thursday it was an open question whether SocGen could survive as an independent player. Today it seems more likely that it will not.

Recommend this article? 0 votes

http://www.theglobeandmail.com/servlet/story/RTGAM.20080124.wreguly0124/BNStory/Business/columnists