Experts at loss to explain failure of trading controls

Officials raise possibility trader had inside help

February 07, 2002|By Paul Adams | Paul Adams,SUN STAFF

How a low-level currency trader for Allied Irish Banks might have been able to bury $750 million in losses without detection is a mystery to bank analysts and those who make their living in the trade.

With more than a trillion dollars changing hands every day, major financial institutions have multilayered systems in place to track profits and losses, as well as suspicious trading activity. What insiders don't catch, auditors are supposed to discover during routine checks of every trader's books.

At Allied Irish's Allfirst Financial Inc. unit, the system broke down, raising the possibility that the trader had help in hiding massive losses on currency trades in a flurry of fictitious options contracts, analysts said.

Allfirst officials have identified the currency trader as John Michael Rusnak, 37, of Mount Washington.

"I can't conceive of a way a person could do it without help," said Christopher Blum, a financial services analyst with Edward Jones. "It's hard to do, and that's why it doesn't happen very often. Usually, the [internal] policies work."

Bank officials, too, were shocked by the failure of internal controls. "We are staggered by the amount of this loss," said Frank P. Bramble, chairman of Allfirst Financial and chief executive of Allied Irish Bank's U.S. operations.

Bramble said the loss occurred in an "isolated" area of the bank "by an individual who found a way to crack our internal control systems."

Unlike trades of stocks and bonds, currency trades are not as heavily scrutinized by government watchdogs, such as the Securities and Exchange Commission. But financial institutions that engage in risky trades usually keep a close eye on their traders, experts said.

In most instances, a trader's profit-and-loss record is tracked throughout the day. Anomalies are checked by a financial institution's internal regulators. Job functions are split up to increase oversight, and jobs are often rotated, making it difficult to hide suspicious activity.

In addition, banks typically use background checks, employee fingerprinting and other methods of detecting fraud by employees, according to the American Banking Association, an industry trade group. When those controls fail, internal and external auditors hired by the company should uncover phony trades.

"There are usually control mechanisms in place and other people who typically review these types of trades," said Alex Beuzelin, a senior market analyst with Ruesch International, a Washington-based currency trading company. "While entering fictitious trades could for a while mask those losses, you have to imagine that they would eventually be caught. It just took longer [in this case] than one would expect."

The suspicious trades took place over 12 months, Allied officials said.

As a currency trader, Rusnak tried to make money by betting that a certain country's currency would rise or fall against another currency over a specific period of time. Such traders tend to work in obscurity, rarely capturing the spotlight in financial circles.

Typically, currency speculators will hedge their position on the spot market with options contracts, which give the trader the option to buy or sell a currency at a certain price in the future.

Usually, losses arising from trades in the spot market would be at least partly offset by profits arising from options contracts, which serve as a bet that the currency will move in the opposite direction. It's pretty standard practice in the industry, experts say. But in this case, the options contracts were fictitious, according to Allied officials. Bank officials said the options purchases were forged to conceal the losses.

Given the dollar amount involved, experts said, the trader should have had a difficult time concealing losses from Allfirst's internal regulators. The amount of the missing funds indicated he had bought fictitious contracts worth many billions of dollars in an effort to conceal his activities, analysts said.

Trades of that magnitude would dwarf the entire trading limit of many large currency trading operations, sounding internal alarms at most institutions.

"If they [the fictitious trades] didn't appear on the corporate balance sheet, that should raise a red flag," said Matthew Snowling, a bank analyst with Friedman, Billings, Ramsey.

But if a trader has help from a colleague, uncovering the fraud becomes more complicated. Allied officials raised the possibility yesterday that there might have been more than one person involved, but said they have no evidence of collusion. The company is conducting an internal investigation.

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