The Société Générale Fraud: More to Come?

If you recall, last Monday, I speculated that we were likely to see a rash of corporate fraud in the aftermath of the credit bubble’s collapse. My reasoning was that the greed that causes people to abandon common sense during a boom/bubble often causes them to cross ethical boundaries as well, once the bubble collapses people are either unable to hide their misdeeds or they turn to fraud to keep the “good times rolling”. I’m not saying anything innovative because this is exactly what happened after the tech crash.

Then, right on cue, at the opening of the European markets on Thursday this story appears: French Bank Société Générale (SCGLY.PK) has reported a loss due to a €5 billion fraud, forcing the bank into an emergency €5.5 billion share issue.

From the Financial Times:

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.

… 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...

From BBC News:

French bank Société Générale says it has uncovered a fraud by a Paris-based trader which resulted in a loss of 4.9bn euros ($7.1bn; £3.7bn).

It also announced new write-downs of 2.05bn euros related to the sub-prime mortgage crisis in the US.

But it said it would still make a profit of 600m to 800m euros for 2007, despite the blow to its balance sheet.

Trading in the bank's shares, which have fallen by nearly 50% in the past six months, has been suspended.

After reading various news stories on the subject I was struck by the fact that when a single trader (a mid-level one at that) was able to cause this much damage to the company, the bank's executives had the audacity to claim that their risk management procedures weren’t at fault. The guy didn’t pilfer laptops from the supply room to sell on eBay (EBAY), he inflicted €5 billion worth of damage that is forcing the company into an emergency share issue. If this is the state of risk management in the banking sector, it’s no wonder they’ve lost billions due to ill-conceived mortgage securities investments.

Maybe this story is an isolated incident that has nothing to do with the usual fraud uncovered in the aftermath of a bubble, then again it could a direct result of the same lax risk management procedures plaguing nearly all banks these days. Either way, don’t be surprised if more rogue traders and surprising frauds are uncovered over the next 6-18 months. After all, I doubt we’ve even scratched the surface with respect to fraud amongst mortgage lenders and brokers.

Sources:

The Financial Times: “SocGen uncovers €5bn fraud” – Martin Arnold, Peter Thal Larsen – January 24, 2008.

BBC News: “Rogue trader to cost SocGen $7bn” – January 24, 2008.

Disclosure: At the time of publishing the author didn’t own a position in Société Générale.