Thursday, January 24, 2008

The $7bn Societe General Fraud

The BBC and pretty much every other media outlet is reporting on the $7bn Societe Generale Fraud. What has not yet come to light is a motive.

The facts as we currently know them are that the perpetrator was responsible for placing trades intended to hedge certain positions held by the bank, essentially insuring against loss. According to some reports the rogue trader did not place the hedge trades, according to others he bet on the assets rising rather than hedging in case they fell. The rogue trades were concealled through his knowledge of the compliance department procedures where he had recently worked.

The other agreed fact is that unlike Nicholas Leeson, the man who broke Barings bank, this rogue trader was not motivated by the size of his potential bonus. He was not meant to be making trading decisions at all. He was meant to follow orders and insure the bank's riskier positions. His salary including bonus was of the order of 100,000 ECU. He was not in line for a bonus if his bets paid off.

What is not understood is his motive: "Executives said the trader may not have sought personal gain from the fraudulent deals."

I don't think this is very likely. When $7 billion is missing from the till Inspector Plod and I both agree: money is going to be a motive.

What I do think quite likely however is that the fraud was not caught because the bank did not anticipate that a person in his position might be able to perform fraud for personal gain and did not watch low ranking traders like him as closely as they should have.

So how could you gain from a fraud of this type?

Let us assume that you can place trades and hide them from the compliance office, that you can hide a surplus (but not a catastrophic loss) and that you cannot transfer money out of the account directly.

The first step in the crime then is to make a surplus. To do this you resort to the old insurance fraud trick of not paying for the policy: The risk manager pockets the insurance premium and hopes that the factory does not burn down that year.

It appears that the trader would have easily established a surplus if the assets had gone up instead

Next the cash out. In the dotCrime Manifesto I describe a variation of the Pump and Dump scam in which the criminal takes over a series of Internet brokerage accounts and invests heavily in thinly traded penny stocks. This drives the price of the stocks up allowing the criminal to cash in their previously purchased holdings for a large profit.

I have no evidence that this was the intention in this particular instance but it is a potential means of cashing out a surplus that the bank could and should have anticipated.

Later: What to do about it.

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