Huffpost Business

Societe General Explains $7 Billion Fraud: Bad Management

Posted: Updated:

PARIS — Investigators at Societe Generale SA say they suspect former futures trader Jerome Kerviel was helped by an assistant to cover up massive trading positions that led to a multibillion dollar loss.

In two long-awaited reports released Friday, the investigators said the French bank's management failures and culture of risk-taking were partly to blame for failing to spot the positions, which led to a loss of more than $7 billion once they were unwound.

The reports detail the extent of Kerviel's alleged fraud in a scandal that broke out in January and has sullied the reputation of the glamorous trading desk at the award-winning bank.

Investigators say Kerviel's bosses missed more than 1,000 faked trades; a huge jump in his earnings in 2007; questions about his trades from the Eurex exchange; unusually high levels of cash flow, accounting anomalies, and high brokerage expenses; Kerviel's failure to take vacation; and his breach of the desk's market risk limit on one position.

"The trader's hierarchy, constituting the first level of control, proved deficient in the supervision of his activities," the board of directors told shareholders in a seven-page statement accompanying the reports.

The reports said Kerviel's direct superior "lacked trading experience" and showed "an inappropriate degree of tolerance" about his trades. The bank did not name the superior, who they said they have been unable to question because he no longer works for the company.

The reports also criticized the manager of the company's Delta One trading desk, who they said was aware of the lack of experience of Kerviel's manager, and "deficiencies in the monitoring of risks by the desk in general."

One report was led by a committee of three board directors, the other by audit firm PriceWaterhouseCoopers. They were published ahead of next Tuesday's annual shareholder meeting. The three independent directors are former auto executive Jean-Martin Folz; Jean Azema, head of insurer Groupama; and Antoine Jeancout-Galignani, a director of real estate company Gecina SA.

Their 69-page report said they "discovered indications of internal collusion involving a trading assistant," whom they declined to identify. They said they were unable to speak to the assistant because of an ongoing judicial probe, adding that it will be up to the court to confirm its suspicions.

However, they said they had uncovered an e-mail which suggested that the assistant must have known about the fake trades.

The assistant's complicity would have helped Kerviel avoid being uncovered, the directors' report said.

Previously, Societe Generale had said it believed that Kerviel acted alone.

But while he had help from a junior colleague, the internal report found that "neither JK's hierarchical superiors, nor his colleagues, were aware of the fraudulent mechanisms used or the size of his positions."

Kerviel says his superiors must have known what he was doing but that they chose to look the other way when he was making money for the bank.

"We notice that while protecting the superiors of Jerome Kerviel, the Societe Generale has found a new scapegoat _ who just happens to be a 23-year-old assistant," said Guillaume Selnet, a lawyer for Kerviel.

He noted that the directors' report was prepared by the bank's own services and insisted that SocGen's version of events keeps changing. The bank issued a preliminary investigation into the scandal in February.

"My feeling is that _ we are now on the second report _ by the third report it's going to be the fault of the cleaning ladies," he added. "Each time it goes down (the corporate hierarchy), instead of up."

SocGen employee Patrice Leclerc, who heads an association of the bank's employee shareholders, said Kerviel's managers need to explain why they missed warning signals that were picked up in Germany _ and why they didn't follow up on questions from Eurex, the German derivatives exchange.

"There exist ways of monitoring this type of thing _ why weren't they used?" he said.

Investigators didn't find any signs of embezzlement by Kerviel, but said it appeared he had sought to boost his results to increase the amount of his bonus. The report established that part of Kerviel's "official" earnings came from his concealed positions.

While the directors' report plumbed the details of the alleged fraud, the 36-page report by PriceWaterhouseCoopers focused on the culture of risk-taking at the bank as it grew its investment banking business and on a review of the measures taken by the bank to fix the problems that the scandal exposed.

"The surge in Delta One trading volumes and profits was accompanied by the emergence of unauthorized practices, with limits regularly exceeded and results smoothed or transferred between traders," the PWC report said.

"Several key controls that could have identified fraudulent mechanisms were lacking" and "there was a lack of an appropriate awareness of the risk of fraud," it said.

The report will be "good news for the lawyers" who are preparing a class action in the U.S. as it spreads the blame, according to Stephane Bonifassi, a French lawyer and a member of the FraudNet network, which operates under the International Chamber of Commerce's commercial crime unit.

For Kerviel, "the fact that his hierarchy was a bit laid-back will help him."

SocGen's board said in a statement to shareholders it approved the conclusions of both reports and their recommendations.

The board said the investment bank is tightening computer security, reinforcing controls and taking more account of the possibility of fraud.

Deeper reforms, such as the creation of a team dedicated to preventing fraud, "significant investments in security for information technology," and a campaign to raise staff awareness have been launched and will be completed by 2010, the board said.

The case is also being investigated by France's market authority, the country's banking commission and a French court.