Societe
Generale was founded in 1864 by a group of industrialists, bankers,
businessmen, and heads of railway companies, after an authorization
decree was signed by Napoleon III. By 1870, it had around 47 branches
in Paris and other provinces in France. In 1871, the bank‘s
permanent office was set up in London and the bank went public.
Between 1871 and 1893, several banking establishments in France
failed after which Societe Generale‘s pace of growth slowed down.
As of 1889, it had 149 branches. In 1894, Societe Generale began
providing short-term credit to traders and industrialists and also
issuing private debenture loans. The bank‘s activities expanded to
Russia at that time.
By
1920, Societe Generale had emerged as a leading bank in France. In
1928, a subsidiary CALIF that specialized in medium-term credit was
created. The 1930s and the early 1940s were a difficult period for
the bank. The operations in France and Europe were adversely affected
by World War II, due to which Societe Generale started scouting for
opportunities in other countries and moved to the US and Africa.
In
1945, Societe Generale was nationalized. Between 1945 and 1958,
France was experiencing economic recovery. It was also a period of
radical changes in the banking industry and the industrial demand for
credit was high. At that time, Societe Generale expanded into Italy
and Mexico. During the 1960s, Societe Generale expanded rapidly in
France and also internationally. With the changes in the banking
sector like the decreasing difference between traditional and
investment banking, advent of the home mortgage market, leasing, etc,
Societe Generale launched services like leasing and opened new
subsidiaries especially for credit.
In
1987, Societe Generale was privatized, after which it began growing
rapidly, both organically and through acquisitions. In 1997, it
acquired Crédit du Nord, which strengthened its position in the
retail banking segment. During the 1990s and 2000s, the bank made
several acquisitions in Romania, Madagascar, the Czech Republic,
Slovenia, and Bulgaria. It also took a controlling stake in the TCW
group, an investment management company. Besides, Societe Generale
continued to make acquisitions in Africa in the 2000s — in Morocco,
Ghana, and Tunisia. Societe Generale‘s asset management and private
banking activities also continued to develop, with the launch of
Societe Generale Asset Management UK, in London and the acquisition
of Japan-based Yamaichi Securities Company Limited, a securities
trading firm. As of 2007, Societe Generale was present in 82
countries across the world. By the end of 2007, its activities were
organized into French Networks, International Retail Banking,
Financial Services, Global Investment Management and Services,
Corporate and Investment Banking.
The
French Networks included Societe Generale and the retail networks of
Credit du Nord and served more than nine million customers. They
operated 2,997 branches across France. The International Retail
Banking division was created in 1998. As of December 2008,
International Retail Banking had a presence in 37 countries across
the world. Its financial services included business finance and
services, consumer credit, and insurance. Global Investment
Management and Services consisted of asset management, private
banking, securities services, custody and clearing on organized
markets, and online banking. Corporate and Investment Banking
services of Societe Generale were offered in 46 countries across the
world and consisted of equities, fixed income, currencies and
commodities, and financing & advisory activities.
The
activities at Delta One included arbitrage trading. Arbitrage or
proprietary trading involved purchasing a portfolio of financial
instruments and at the same time, selling another portfolio of
similar financial instruments, with slightly different value, thus
taking advantage of the difference in valuation of correlated assets.
Arbitrage traders were required to ‗go long‘ for one set of
portfolios, i.e. bet that the value would go up in a specified
period. At the same time, they were required to ‗go short‘ for
the other set of portfolios i.e. bet that their value would go down
in the same period. They gained through minute price differential
between these two sets of portfolios. When a minor price difference
arose between the portfolios, the arbitrage traders capitalized on
it.
As
the difference between the values of both the portfolios was very
small, trading in these portfolios involved operations with high
nominal amounts. This was low risk investment, as both the portfolios
had similar characteristics and offset each other. Traders involved
in arbitrage were not allowed to take open positions (positions that
speculated the rise and fall of markets).
Kerviel
(born January 11, 1977) joined Societe Generale in August 2000 after
graduating in finance from Lumière University Lyon 2, France.
Initially, he worked in the back and middle offices, where his job
involved processing and overseeing transactions made by the traders.
In 2004, he was promoted as a trader assistant, and worked on risk
analysis and hedging. In 2005, Kerviel was transferred to the Delta
One trading desk where he held the post of equity index arbitrage
trader (Refer to Exhibit III for reporting structure of Kerviel at
Delta One). At Delta One, Kerviel was an arbitrage trader
specializing in the European stock markets. His main responsibilities
included handling proprietary deals in the futures market. He was
required to purchase a portfolio of stock index futures and at the
same time sell a similar mix of futures, with slightly different
value. Explaining Kerviel‘s responsibilities, Jean-Pierre Mustier
(Mustier), Head, Investment Banking at Societe Generale, said, ―His
job was to make bets on small price differences between contracts,
not to trade on the markets‘ direction. Kerviel was required to
trade in Turbo Warrants and was asked to maintain a hedged position
at all times. The net value of his portfolio was to be maintained at
€ 500,000 and the net position was not to exceed the risk limit
that was pegged at € 125 million. In financial circles, arbitrage
trading was considered to be less glamorous than one way transactions
and less risky too.
According
to Robert Youngman, Portfolio Manager with Griffin Asset Management
Inc., an investment management firm, ―It‘s low risk kind of
investing, unless you get it wrong. You see a minor spread between
the portfolios show up every once in a while and capitalize on it.
The origin of the fraud dates back to June 2005, when Kerviel began
taking directional bets in small amounts and covering these with
fictitious transactions in the opposite direction on the European
stock market indices like Euro Stoxx 507, German DAX8 and FTSE 1009.
The financial instruments in the original portfolio were subjected to
the risk limit and margin calls with clearing houses10. As long as
the financial instruments in the portfolio were purchased and Societe
Generale considered them purchased, the margin calls were checked and
settled.
An
incident that occurred in 2005 made Kerviel sure about his ability to
earn profits from his directional bets. According to Kerviel, ―The
best trading day in the history of Societe Generale was September 11,
200111. At least, that‘s what one of my managers told me. It seems
that profits were colossal that day. I had a similar experience
during the London attacks in July 2005. In July 2005, Kerviel made a
shorting bet on the stock of Allianz13. In Kerviel‘s own words, ―I
then took a position on Allianz, betting the markets would fall. It
just so happened that a little while later, the market fell after the
London bombings and it‘s the jackpot, € 500,000. To make it
appear as if the stock had been hedged, he created a fake long
transaction. He said, ―I had mixed feelings because I was proud of
the result, but surprised at the same time. That produced a desire to
continue. There was a snowball effect. With the initial successes,
Kerviel continued to take directional calls on the market, without
hedging. As his confidence grew, he began building up unhedged
positions. In 2005 and 2006, Kerviel took positions primarily on
equities. Between June 2005 and February 2006, the fraudulent
transactions were valued at € 15 million. These increased to €
135 million after February 2006 till the end of the year. He took
directional bets above € 5 million each on the equities of Allianz,
Solarworld, and Q-Cells.
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