Rogue trader exploits IT knowledge to cost bank billions

Biggest fraud in investment banking history

French banking group Societe Generale (SocGen) has reported a £3.6 billion (AU$8.2 billion) loss due to the fraudulent actions of a rogue trader who used his "in-depth knowledge" of the bank's fraud control systems to circumvent internal checks.

Jerome Kerviel, a Paris-based trader working on the bank's European equities derivatives desk, used knowledge gained from his previous position in the middle office to take fraudulent positions in 2007.

Kerviel built up large positions and made unauthorized bets on stock index futures, and as his losses mounted he covered his tracks by using his knowledge of the bank's technology systems.

"Aided by his in-depth knowledge of the control procedures resulting from his former employment in the middle office, he managed to conceal these positions through a scheme of elaborate fictitious transactions," said Societe Generale in a statement. "Additional control procedures were immediately implemented."

In a press conference, chairman Daniel Bouton said: "This was a lone man who built a concealed enterprise within the company, using the tools of Societe Generale, and who had the intelligence to escape all control procedures."

Bob McDowall, senior analyst at TowerGroup, said: "What puzzles me is how someone could have this ability to commit fraud across all these different systems. There would be a number of different systems -- such as regulatory, risk, trade systems, settlement, pending settlement systems, funding requirements. There are different people running these systems, with different operations and compliance. I would have thought that people would have noticed these actions and I wonder how one man could shut off the control alarms in all the systems."

McDowall added that it was "quite unusual" for employees to move from back or middle office to front. He said it was clear Kerviel was "an average trader, not a high flying trader" so he would not have been given the greater authority for larger risk position, according to McDowall.

Chris Skinner, chief executive at consultancy Balatro, said moving an employee from the back office to the trading floor was a decision that heightened the risk of rogue trading.

"Virtually every occurrence of rogue trading has been for the same reason [moving from back office to the front office]," Skinner said. "It's fundamental in investment banking and trading that the person that books the orders shouldn't administer the position and pay the commission. You wouldn't let a salesman pay his own commission."

Ralph Silva, senior analyst at TowerGroup, said: "Fraud prevention is a fundamental aspect of operational risk. SocGen has undergone a failure in their operational risk program. Operational risk lags behind the ability of fraudsters to take advantage of loopholes."

Silva added that banks could never entirely remove the risk of fraud. "Insider knowledge allowed red flags that should have been apparent to be avoided. In other words: complacency in monitoring must never be allowed -- new methods of forensics constantly need to be found.

"SocGen's balance sheet is extremely strong and they have undergone relatively low levels of subprime related loses. This fraud level will not be lethal [but] the fraud-based losses may require additional capital to meet adequacy regulations," said Silva.

The loss has taken a huge chunk out of the bank's profits for 2007. It will announce its full year results on Feb. 21, and said it expects net income to be between £600 million to £800 million.

The fraud is has been labelled the biggest in investment banking history. In 1995, Barings Bank bore a US$1.4 billion (AU$1.59) loss due to the actions of a rogue trader, Nick Leeson, who was hiding losses in bets on Nikkei futures.

Leeson told the BBC he was not shocked that it had happened again, but the numbers involved in the latest scandal had left him staggered.

"The first thing that shocked me was not necessarily that it had happened again -- I think rogue trading is probably a daily occurrence amongst the financial markets. The thing that really shocked me was the size," said Leeson.

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Siobhan Chapman

Computerworld UK
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