Updates Galore – Société Générale, Risk, and Control

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Update:
They’ve chosen PwC to advise the Board’s investigative committee. Unfortunately this presents a significant independence conflict as the most likely bank to buy SocGen is BNP Paribas.

Guess who their auditor is? You got it. PricewaterhouseCoopers!

The other French bank discussed as a possible buyer? Credit Agricole. Their auditors: PwC and EY!

The board of troubled French banking giant Societe Generale said Wednesday that chairman and chief executive Daniel Bouton will stay on despite massive trading losses of more than $7.2 billion. The board said it had rejected Bouton’s resignation, as well as that of co-chief executive Phillipe Citerne, his second-in-command.
The announcement came at the end of a special board meeting at Societe Generale’s headquarters in the Paris suburb of Neuilly-sur-Seine to discuss the losses, which Bouton has attributed to fraud by one of the bank’s traders.

Board members also announced the creation of a special committee to look into the causes and extent of the losses the bank incurred. In addition to the alleged fraud, the bank last week also announced a nearly-$3 billion writedown due to the U.S. subprime mortgage crisis. The special committee will include independent directors, the board said, and will look into measures that have been put in place to prevent a recurrence. The committee will call on the audit services of PricewaterhouseCoopers, the board said.

Société Générale to call in independent auditors
The board of Société Générale is set to call in independent auditors to examine the events leading up to the biggest rogue trading scandal in banking history, as directors on Tuesday sought to bolster Daniel Bouton, chairman, ahead of a board meeting on Wednesday.

But who? There’s only KPMG or PwC, since they’re already entangled with Deloitte and EY. Or maybe they’ll call in Debevoise who will hire one of the above… But, dear Debevoise, be careful and make sure that the firm you hire is really independent.

A tip just came in pointing me to KPMG’s 2006 Annual Report. It seems they too are in bed with SG.

“KPMG has worked closely with Société Générale in many countries and across its different businesses. We have helped the bank grow in new banking markets such as Russia, China and India, and have provided advice on tax and employee services as well as risk management advice for both its investment and corporate banking businesses. In France and abroad, we have also assisted the bank in implementing IFRS and introducing Basel II reforms.

But the relationship grew deeper in 2006 when the bank asked us to sign a global service agreement which would match its increasingly global footprint. This has allowed us to rethink how we serve this client around the world and to map the strategies we provide the bank much more closely against its challenges and needs. ”

My contact says PwC also provides extensive advisory services to SG.

So none of the Big 4 are independent enough to do an independent, objective, thorough investigation and not be compromised by their desire to continue their lucrative relationships with SG or a potential successor acquiring bank. According to this source, none of the Big 4 will talk to journalists about Société Générale .

What to do?

Dear Mr. Walker: This is the problem with “too few to fail” and the failure of resolve of our regulators to do something about this issue.

We shall see.
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So much is, and has been, written about this scandal that I hesitated. What more can I say?
For a good overview from the fraud perspective, go here.
For a good summary of the in-depth articles, go here.

The Economist seems to be the only one asking the questions that are on the tip of my tongue:

“In SocGen’s version of events, Mr Kerviel acted alone to build a fictitious portfolio of transactions that appeared to balance out the real trades that he was making in European futures.

One set of thorny questions relates to how he was able to fake those offsetting positions: in particular, was the IT drawbridge properly raised when he made his move out of the back-office and onto the trading desk in 2005? Clear segregation of back-office and front-office activities was one of the clearest lessons to emerge from the rogue-trading scandal at Barings Bank in 1995; at SocGen, those lines seem to have blurred.

Veterans of the futures markets are baffled about how Mr Kerviel got away with building up such a big position unnoticed. Most observers, regulators included, concede that banks can do little to stop determined individuals from sidling around some controls. But miscreants should be found out long before matters get as far out of hand as they did at SocGen.

Why was the bank only looking at net exposure and not Mr Kerviel’s outsized gross positions? Why didn’t the margin calls on Mr Kerviel’s real trades (likely to have been in the order of €2.5 billion on a €50 billion position) trigger alarms?

Why didn’t an alleged warning in November from the Eurex derivatives exchange that something was amiss about Mr Kerviel’s trades stop his activities?
And why didn’t the traders and supervisors sitting next to him notice oddities in his behaviour?

Worse, were they themselves somehow complicit? “

The Société Générale 2006 Annual Report devotes quite a few pages to the subjects of risk management and controls.

First, they discuss the elaborate internal control organizational structure and its interaction with the Audit Committee. Pages 89-95 describe the internal control organization and how the internal audit function carries out inspections.

On page 99, we see the report on internal controls prepared and signed by the dual auditors under French law who review Société Générale’s books and records and have provided a clean opinion, agreeing with management’s assessment of internal controls. There were no exceptions cited. Société Générale has the benefit of both Ernst and Young and Deloitte to assist them in making sure everything is in order and functioning to produce financial information that is valid, true and complete.

There’s an entire chapter, pages 127-150, of the annual report devoted to Risk Management. This section covers all the risks they face and the myriad of policies, procedures, organizations and systems they, theoretically, have in place to manage them.

So what happened?

I’m of the cynical, conspiracy-minded opinion that they were losing money big in other areas, this young man was supposed to make big bets to try to recoup or offset these losses, they loosened or have loose controls in IT and other areas so that he could build these mirror portfolios without obstacles, and he is the poor schmuck left holding the bag when management panicked.

As Kerviel tells all, I am sure you will see that words do not a control structure make, if someone doesn’t buy him off first. Everything rational goes out the window when the big guys’ jobs are at stake.

I will be following this story closely.