French bank uncovers massive fraud by futures trader

? Last Sunday, Societe Generale Chief Executive Daniel Bouton got the call every banking chief dreads.

Undetected by multilayered security systems at the bank, France’s second-largest, 31-year old junior trader Jerome Kerviel had for more than a year been fraudulently using company funds to bet on European stock markets – wrongdoing that was going to cost the bank billions.

The timing could not have been worse: Stock markets suffered their blackest day since the Sept. 11 terrorist attacks on Monday, meaning Societe Generale was forced to sell the contracts built up by the rogue trader just as bourses were plunging.

It took the bank three days to unload them, and appeared to be the largest trading fraud ever carried out by a single person.

The losses, Societe Generale announced Thursday, amounted to 4.9 billion euros, or more than $7 billion – making it one of history’s biggest banking frauds and prompting immediate calls for tighter regulation of the industry.

Societe Generale said Kerviel – described as a “brilliant” student by one of his former university teachers – appears to have netted no personal gain from the scheme.

The company said it expects to post a net profit of 600 million to 800 million euros ($874 million to $1.16 billion) for all of 2007 – even after the fraud and another 2.05 billion euros ($2.99 billion) lost in the subprime mortgage crisis.

As a result, the bank said it would be forced to raise about $8 billion in new capital, partly by selling shares in a rights offer underwritten by JPMorgan Chase and Morgan Stanley.

Moody’s Investors Service late Thursday downgraded Societe Generale’s bank financial strength rating to “B-” from “B” and assigned a “negative” outlook to the rating, which means the rating could be cut later. Moody’s also downgraded the bank’s long-term debt and deposit ratings to “Aa2” from “Aa1” but kept those ratings’ outlooks “stable.”

Among the many questions were how and why Kerviel perpetrated what the bank described as a fraud “exceptional in its size and nature.”

Kerviel, employed by the bank since 2000, had worked his way up from a supporting role in an office that monitors trades to a job on the more glamorous futures desk, where he invested the bank’s own money by hedging on European equity market indices – making bets on the future performance of the markets.

Kerviel was involved in what the bank calls “plain vanilla,” or the more basic forms of hedging, with limited authority. He took home a salary and bonus of less than 100,000 euros, or about $145,700 – relatively modest in the financial world.

The bank said he went far beyond his role – taking “massive fraudulent directional positions” in various futures contracts, betting at the start of this year that stock markets would rise.

He apparently escaped detection by using knowledge of the bank’s control systems gleaned in his earlier monitoring job.

Most of his positions went unnoticed by colleagues and superiors as Kerviel covered his tracks with what the bank described as a “scheme of elaborate fictitious transactions.”

He got caught when markets dropped, exposing him in contracts where he had bet on a rise.

The bank filed a legal complaint Thursday accusing Kerviel of fraudulent falsification of banking records, use of such records and computer fraud.