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Unformatted text preview: Paris le XX January 2008 Explanatory note about the exceptional fraud
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 1 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
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
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
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. 2 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
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
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
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 3 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%, 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%) 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% of volumes traded on the relevant
futures indices (EUROSTOXX, the DAX and the FTSE).
volumes of positions
unwound on the
markets (as a %)
21 January 2008
22 January 2008
23 January 2008 Eurostoxx DAX FTSE 8.1%
0% The position was finally fully closed or hedged on the evening of January 23rd.
Overall, movements in the market triggered by the sharp fall in the Asian markets
during the night of January 20th to January 21st resulted in a final total loss of
4.9 billion euros. 4 Our statutory auditors and the relevant regulatory authorities were informed of the
details of the initial positions and of the unwinding operations.
On January 26th 2008, the regulatory authorities were informed of the analysis of the
methods used to perpetrate the fraud and the corrective measures taken. 5. Measures taken with immediate effect
Over the last week, teams at Société Générale have reviewed all the operations
which took place from the trader’s workstation and any transactions bearing a
possible resemblance to the fraudulent operations discovered. Moreover, the futures
position has been checked against our counterparty (clearer). This review has
strengthened our conviction that all the fictitious operations had been identified as of
Specific control procedures have been implemented so that the techniques devised
by the trader to avoid controls can no longer be applied. The regulators have been
informed of these changes and of the dates of their deployment.
Lastly, beyond these specific measures, additional controls will be launched.
Significant human resources will be mobilized for this project, with the support of
external specialists in fraud techniques. It will be supervised by the Audit Committee. 5 ...
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