No Défense

The humiliated French bank Société Générale has plenty more explaining to do before putting its rogue-trader scandal behind it.

An old line of Hank Paulson’s has been dusted off since news broke of a €4.9 billion ($7.2 billion) trading loss at Société Générale, France’s second-largest bank. “We will never eliminate people doing bad things,” the former head of Goldman Sachs, now America’s treasury secretary, once said. “In a town of 20,000 people, there’s a jail.” The question now being asked of SocGen is: shouldn’t there also be a police force?

In fact, SocGen has plenty of internal cops at its high-security headquarters in the La Défense enclave of Paris. The bank’s annual report for 2006 devotes 26 reassuring pages to its risk-management practices; more than 2,000 staff worked in the function that year, and lots more bodies were added in 2007. Yet none of them stopped Jérôme Kerviel, the trader accused of taking enormous unauthorised bets, from building an unhedged €50 billion exposure to European futures markets (Mr Kerviel reportedly alleges that his supervisors were aware of his activities).

On January 28th Mr Kerviel was placed under formal investigation for abuse of trust, breaching computer security and falsifying documents. Two days later Daniel Bouton, SocGen’s chairman and co-chief executive, survived a board meeting to consider his handling of the affair. He was lucky. Holes have not only appeared in the bank’s accounts; its initial version of events is also looking threadbare.

Mr Bouton’s description of Mr Kerviel as having “an extraordinary talent for dissimulation” certainly looks less convincing as more details emerge. Although Mr Kerviel was properly found out on January 18th, he had tripped alarms inside the bank well before then. “When challenged, he was clever enough to say, for example, that he had made a mistake,” says Jean-Pierre Mustier, the head of SocGen’s investment-banking arm. Clever, indeed. Rival banks, admittedly fortified by anonymity, say that their traders would not have been able to keep getting away with that kind of explanation. Some people wonder if SocGen would have blown the whistle at all had the bets been profitable. Outsiders raised other suspicions. Eurex, Europe’s largest futures exchange, contacted SocGen about oddities in trading patterns in late 2007, which the Paris prosecutor says referred to Mr Kerviel’s positions. The bank says that Eurex’s questions were rather technical in nature and that it had responded to them.

The sheer size of Mr Kerviel’s exposure, the losses on which tripled as SocGen frenetically unwound its positions between January 21st and 23rd, has caused most bafflement among veterans of the futures markets. Two big blind spots saved him from detection. The first was the bank’s focus on traders’ net exposure, the difference between the portfolios that are being arbitraged. Mr Kerviel did not have a defined gross-exposure limit. By creating a fictitious portfolio of trades that appeared to balance those he was really making, his net exposure stayed within set ranges and he remained below the radar.

Why didn’t the margin calls on Mr Kerviel’s real trades (likely to have been of the order of €2.5 billion on a €50 billion position) trigger alarms? This was the second blind spot. According to Mr Mustier, margin data from Eurex showed only consolidated positions. These positions were “not a different order of magnitude” from the volumes expected of a big investment bank. “One lesson of this is that it is important to see what is attributable to each trader,” he says. In truth, that should not have been too difficult: as well as consolidated figures, Eurex says it does already send data that tie margins to specific traders on a daily basis.

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