The New York Times-20080128-Bank Outlines How Trader Hid His Activities

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Bank Outlines How Trader Hid His Activities

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The French bank Societe Generale, facing persistent questions over how a lone, junior trader could have instigated more than $7 billion in losses, acknowledged on Sunday that his activities prompted questions from risk managers several times last year, but that the bank never began an investigation because his explanations defused any suspicions.

The disclosure came as the trader, Jerome Kerviel, 31, spent a second day in police custody, facing questions about what the bank asserts was an elaborate, yearlong ruse that involved betting tens of billions of dollars of the bank's money on European stock index futures.

Mr. Kerviel's lawyers late Sunday denounced what they called the media lynching of their client in recent days and argued that the bank's managers brought the loss on themselves.

In a five-page statement, the bank outlined how it believed Mr. Kerviel combined several different fraudulent methods to hide his activity -- including using computer access codes of other employees and falsifying documents.

Briefing reporters separately by telephone, Jean-Pierre Mustier, chief executive of the bank's corporate and investment banking arm, said that the discovery of the $7.2 billion fraud on Jan. 18 and the unwinding last week of the roughly $70 billion worth of risky investments that were uncovered represented one of the most difficult periods in the history of Societe Generale.

Mr. Mustier also repeated the bank's assertion that Mr. Kerviel appeared to have acted alone.

We have made extensive checks of his portfolio as well as the portfolios of others to see if there was anything like the types of transactions he was using, Mr. Mustier said. It seems extremely unlikely that he was helped by others, he said.

Mr. Mustier explained that Mr. Kerviel's role on the trading desk was that of an arbitrageur, which meant that he was entrusted to purchase one portfolio of stock index futures and at the same time sell a similar mix of index futures, but with a slightly different value. The object of arbitrage is to try to make profits from these differences in value.

Because the value gaps between similar financial instruments are usually very small and temporary, this type of activity typically involves trading in very high total nominal amounts.

Mr. Kerviel's fraud, according to the bank, consisted of placing sizable, real purchases in one portfolio but creating fictitious sales transactions in the second, offsetting portfolio. This gave the impression to risk managers that the risks in the first portfolio were hedged, when in fact they were not.

As a result, the bank wound up exposed to huge one-way bets, or long positions. Instead of hedging, which was his job, Mr. Kerviel was effectively speculating with the bank's money.

Mr. Mustier said a review of Mr. Kerviel's trading records showed that he began creating the fictitious trades in late 2006 and early 2007, but that these transactions were relatively small. The fake trading increased in frequency, and in size, during the course of the year, he said, but the largest fictitious trades -- involving futures contracts on the Dow Jones Eurostoxx 50, the German DAX and the FTSE index in London -- were entered in early January.

Our controls identified from time to time problems with this trader's portfolio, Mr. Mustier said, although he declined to say when the first questions were raised by risk managers, saying that the bank's auditors were still investigating.

Each time one of Mr. Kerviel's trades was questioned, he would describe it as a mistake and cancel the trade, Mr. Mustier said. But in fact, he then replaced that trade with another transaction using a different instrument to avoid detection, he said.

Mr. Mustier also said that Mr. Kerviel's fake trades did not fall into an identifiable pattern.

He had a lot of various transactions that he would use, Mr. Mustier said. I don't think there was ever an exact repeat of a trade.

Mr. Kerviel surrendered to the police on Saturday afternoon. French investigators spent the weekend questioning him and poring over documents and computer files seized from his residence and from the bank offices where he had worked.

On Sunday, his lawyers, Elisabeth Meyer and Christian Charriere-Bournazel, accused the bank's management of wanting to raise a smokescreen to divert public attention from far more substantial losses in the last few months, notably in the area of subprime mortgage investments.

The lawyers criticized Daniel Bouton, the bank's chief executive, saying he had published a public letter under the pretext of reassuring shareholders that accused Mr. Kerviel of fraud. On the contrary, they argued, Mr. Kerviel actually made the bank a profit of $2 billion as of Dec. 31.

Laura Schalk, a Societe Generale spokeswoman, declined to comment on the contentions of the lawyers.

On Sunday, the head of the financial section of the Paris prosecutor's office, Jean-Michel Aldebert, said the questioning of Mr. Kerviel had so far been extremely fruitful.

Mr. Aldebert said that Mr. Kerviel's state of mind seemed stable. According to what he told me, he's doing fine, he said.

Societe Generale executives had previously described Mr. Kerviel as a fragile being who had recently faced family problems.

Mr. Aldebert said Mr. Kerviel would be held until Monday morning and was then expected to be interviewed by a judge.