Saturday, January 26, 2008
Legal cultures respond differently to reports of wrongdoing, and the disclosure of the massive fraud in France perpetrated by a "rogue trader" identified as Jérôme Kerviel shows how different things can be. One of France's oldest banks, Société Générale was chartered in 1864 by Napoleon III and is now the country's second largest publicly traded financial institution, well-known for its extensive and heretofore sophisticated derivatives trading operation. The controls on the trading desk were somehow circumvented by Kerviel, described as a mid-level trader, whose transactions in European stock index options and futures totaled as much as €40 billion and ended up down over €2 billion when discovered on January 19. Société Générale secretly began to unwind the trades over three days beginning on Monday, January 21, in the midst of a market meltdown that may have been exacerbated by its transactions. The sales triggered even greater losses for the bank, with the total estimated at €4.9 billion, or about $7.2 billion, from Kerviel's investments. This surely ranks among the largest financial frauds ever, and raises serious concerns about Société Générale's internal controls -- how do you not notice positions as large as €40 billion in your portfolio, even if computer programs to flag these types of risk were circumvented?
The interesting point is not so much the size of the losses, but the response of the bank and French authorities, in contrast to how U.S. regulators and prosecutors would have acted when informed of similar conduct. As an initial matter, it appears that Société Générale informed very few officials in the French government of the problem. While the governor of the Banque de France, Christian Noyer, was kept abreast of the issues, upper levels of the French government did not learn of the problem until the day before its disclosure (see Bloomberg story here). Meanwhile, Société Générale tried to get out of the investments without making any disclosure to protect itself from even greater losses, which could be viewed as favoritism by the Banque de France. I suspect that a U.S. bank could not get away with disclosing such problems to only one banking regulator, such as the Comptroller of the Currency or the Federal Reserve, while keeping the rest of the government in the dark about transactions involving this type of misconduct. When the news emerged, neither Société Générale nor the Banque de France issued any statement, or at least there's nothing on either's website discussing Kerviel's fraud (see here and here). It is hard to imagine federal regulators not taking the lead on such an issue to explain how the government will respond.
The biggest question, however, is where are the prosecutors? The French system is obviously quite different in its approach to criminal investigations, with magistrates conducting investigations. But according to news reports (see Bloomberg here), Kerviel is "on the run" and not in custody, seemingly having slipped away. Société Générale interviewed him on January 19 to figure out what he had done, and Kerviel was around at least in the early part of this week. In the United States, there is no doubt that a trader accused of such conduct would have been in custody the moment the government learned of the fraud. Indeed, the banking regulators would likely have contacted prosecutors before doing anything on the case, assuming they found out first, and not kept the Department of Justice in the dark. Kerviel's motive for engaging in the transactions is unknown at this point, and it does not appear he was an embezzler or somehow sent the money abroad, at least to this point. His disappearance, however, raises questions about the handling of the case, and I suspect the French authorities hope he does not show up in Namibia or a like jurisdiction. (ph)
UPDATE: An AP story (here) states that Kerviel is now in custody as part of the criminal investigation of his trading. (ph)