Paris, January 27th 2008
The present document describes the arbitrage activities, the method behind the
fraud, the conditions in which the fraud was uncovered, the unwinding of the
fraudulent position and the measures taken with immediate effect, as
revealed by Société Générale’s investigations at January 26th 2008.
On January 29th, the Audit Committee will take a decision on an additional
external audit.
1. The arbitrage activities and an explanation of the size of the nominal
amounts used in the fraud.
It is not the role of Société Générale’s Equities businesses to take
directional positions on the equity markets (i.e. to speculate on rises or
falls). The division where the trader worked is assigned to arbitrate
financial instruments on European stock markets. This is a proprietary
trading business which is completely independent of the Equities activity’s
client businesses.
For example, this arbitrage business involves purchasing a portfolio of
financial instruments A and selling at the same time a portfolio of
financial instruments B with extremely similar characteristics, but with a
slightly different value. The arbitrage business generates its profits or
losses from these differences in value.
Because these differences are both small and temporary, the arbitrage
activities rely on a very large amount of operations involving very high
total nominal amounts.
The fact that portfolios A and B have very similar characteristics and that
they offset each other, means that these activities generate very little
market risk.
However, these risks do exist and, as part of the development of its arbitrage
activities, Société Générale has put in place a large number of controls
designed to monitor the risks involved: control of operations and control of
market risk linked to the changes in the prices of portfolios of financial
instruments.
The exceptional fraud which we have suffered consisted of avoiding these
controls or making them inoperable: the trader inserted fictitious
operations into portfolio B in order to give the impression that this
portfolio genuinely offset portfolio A which he had purchased, when this was
not the case.
These fictitious operations, were registered in Société Générale’s systems but
did not actually correspond to any economic reality.
2. The method behind the fraud
• The trader involved had been employed at the Group since 2000. He first
spent five years working in different middle-offices (one of the departments
which controls traders). Consequently, he had a very good understanding of
all of Société Générale’s processing and control procedures. In 2005, he
became a trader in the arbitrage department.
In the course of his arbitrage activity, the trader developed an initial
portfolio A comprising genuine operations using financial instruments
(futures) which reproduced changes in the main European stock market indices
(Eurostoxx, the Dax, the FTSE, etc.).
The financial instruments in the portfolio, which were genuine and consistent
with the volumes traded by a large investment bank, were subject to daily
controls and in particular margin calls with the main clearing houses.
Insofar as these instruments were actually purchased and considered as such
by Société Générale, the margin calls were checked and settled by or paid to
the bank.
• The risks generated from commitments made by the bank are managed and
controlled on a daily basis. With regard to this fraud, the financial
instruments in portfolio A were in appearance offset by the fictitious
operations housed in portfolio B, which meant that the only visible risk was
very low residual risk.
As a result, the trader was able to hide a very sizeable speculative position,
which was neither consistent with nor related to his normal business
activity for the bank.
In order to ensure that these fictitious operations were not immediately
identified, the trader used his years of experience in processing and
controlling market operations to successively circumvent all the controls
which allow the bank to check the characteristics of the operations carried
out by its traders, and consequently their real existence.
In practice, the trader combined several fraudulent methods to avoid the
controls in place:
- firstly, he ensured that the characteristics of the fictitious operations
limited the chances of a control: for example he chose very specific
operations with no cash movements or margin call and which did not require
immediate confirmation;
- he misappropriated the IT access codes belonging to operators in order to
cancel certain operations;
- he falsified documents allowing him to justify the entry of fictitious
operations.
- he ensured that the fictitious operations involved a different financial
instrument to the one he had just cancelled, in order to increase his
chances of not being controlled.
3. The conditions in which the fraud was uncovered
• Friday January 18th
- Abnormal counterparty risk on a broker is detected several days earlier.
The explanations provided by the trader result in additional controls.
- On January 18th, the trader’s superiors are informed and in turn they alert
the management of the division.
- In the afternoon of January 18th, it appears that the counterparty for the
recorded operations is in fact a large bank, but the confirmation e-mail
raises suspicions.
- A team is immediately created to start investigating the situation.
• Saturday January 19th
- Management cannot obtain a clear explanation from the trader.
- The large bank in question does not recognise the operations.
- The trader finally acknowledges committing unauthorised acts and, in
particular, creating fictitious operations.
- The investigation team starts piecing together his real position.
• Sunday January 20th
- During the morning, all of the positions are identified.
- In the early afternoon, the extent of the total exposure is known.
- Daniel Bouton immediately informs the Governor of the Banque de France.
- A meeting of the Audit Committee has been convened in the afternoon of
Sunday January 20th to examine the estimated results for 2007 and the
write-downs related to US residential mortgage assets (in particular CDOs),
prior to the meeting of the Board of Directors at 18:30 on the same day.
The Chairman informs the members of the Committee of the trader’s position
which has just been uncovered. He indicates that he has decided to close the
position as quickly as possible and, in accordance with market regulations,
to postpone all communication on this issue and on the estimated results
until said position has been closed.
- Daniel Bouton then informs the general secretary of the AMF.
- At the Board meeting, the Chairman explains that it is impossible to
communicate on the estimated results for 2007 on account of the discovery of
problems in certain market activities, which could result in substantial
losses.
• Monday January 21st
- The unwinding of the fraudulent position begins in particularly
unfavourable market conditions.
• Wednesday January 23rd
- The unwinding of the fraudulent position is completed.
- Another Board meeting is convened on Wednesday January 23rd, the day when
the position is closed, and its members are fully briefed on the facts and
their repercussions.
• Thursday January 24th
- Before the markets open, the existence of the fraud and its repercussions
are relayed to the markets. Société Générale asks for trading in its shares
to be suspended.
Investigations are under way by Société Générale’s General Inspection division
and the Banque de France and will confirm the exact circumstances of the
fraud. The police have begun an inquiry.
4. The unwinding of the fraudulent position
The equivalent nominal amount of the fraudulent position uncovered on Sunday
January 20th was approximately 50 billion euros.
The priority was to unwind the fraudulent position as quickly as practicable,
given the risk generated by its size. The unwinding could only start on
Monday January 21st and in a measured fashion so as keep volume levels under
10 per cent, in order to respect the markets’ integrity.
Conditions in the market were very unfavourable. In the afternoon of Friday
January 18th, there had been a sharp downturn in the European markets. In
the night of January 20th to January 21st, there was a significant drop in
the Asian markets (Hang Seng down –5.4 per cent) before the European markets
opened.
The position was unwound over three days in a controlled fashion, thus
ensuring that Société Générale did not exceed around 8 per cent of volumes
traded on the relevant futures indices.
