Trader's bets unusually large for size of bank, experts say

Analysts believe Rusnak mishandled investments in yen

February 08, 2002|By Paul Adams and Bill Atkinson | Paul Adams and Bill Atkinson,SUN STAFF

The Allfirst Financial Inc. foreign currency trader who is believed to have lost a staggering $750 million likely placed abnormally large bets for the size of the bank at which he worked, experts said yesterday.

At a minimum, they added, he was poorly supervised and might not have acted alone.

Experts said the Allfirst currency trader, John Michael Rusnak, 37, of Mount Washington, probably had multiple investments in Japanese yen, paid large sums of money so he had the right to buy more yen and made bets that simply proved wrong.

The size of the loss at Baltimore-based Allfirst, which had been operating a two-man currency trading desk until this week, surprised even experts who have been in the business for decades.

"How can you lose $750 million without taking some pretty extreme risks and obviously risk beyond what you are authorized to take?" asked John Hull, professor of finance at the University of Toronto.

"It is quite a task" to lose that much money, added a veteran currency trader who requested anonymity. "In order to lose that sum of money in a course of a year, positions would probably need to be in excess of a billion dollars at times. It would be a large sum for this bank in particular."

Wednesday, Allfirst dropped a bomb when it announced the loss and called Rusnak a "rogue" currency trader responsible for a "sophisticated, well-thought out fraud" that was "cleverly done."

The bank claims that he hid trading losses by creating fictitious options trades and by overriding internal systems designed to detect irregularities.

Rusnak, who was said to be a model employee, did not show up for work Monday after bank officials began questioning his trades and has since retained a lawyer. He has not been charged with a crime.

Rusnak's trading losses occurred during a period of about a year. Losses mushroomed as Rusnak made bets on the yen, Allfirst officials said.

Experts believe that Rusnak, expecting the yen to rise in value, was likely adding to his positions so that the value of the holdings was over 1 billion dollars.

"John was trading much, much larger sizes than even bank traders at the largest banks," the veteran trader said.

He might have spent large amounts of money on options premiums, which would reserve the right for him to purchase more yen at a set price during the year, the trader said.

"He more than likely had a constant position," said Dan Stark, president of Daniel B. Stark & Co., a San Diego-based research and consulting firm that provides performance figures on commodity trading advisers. "He could have been trading daily, but he was probably holding on to some positions overnight. If he wasn't getting out of his positions and the position was going against him, the losses would continue to build."

Bank officials alleged Rusnak concealed the losses by recording phony contracts on options that would have hedged bets that turned sour. Such fraud, experts said, often happens in cases in which a trader tries to evade discovery long enough to get out of the hole.

"You make a small loss and then try to get it back by doubling up," said Hull, the finance professor. "You have to take an even bigger risk on the second round to make up for the loss from the first round." If the tactic succeeds, managers often look the other way, Hull said.

In Rusnak's case, not hedging proved disastrous, because the value of the yen continued to fall sharply against the dollar.

"It wouldn't take long for things to get seriously out of hand," said Phillip Thorpe, president of the Institute for Financial Markets, a Washington-based education foundation for the futures and options markets. "If you are on the wrong side of those contracts, you could have seen a fairly substantial drop in your book. If it was unhedged and improperly disclosed, it could easily get out of hand."

Financial and risk-management consultants said it would be difficult for a trader to lose $750 million undetected unless a bank's internal controls suffered a major breakdown. Banks typically have layers of checks and balances.

It starts in the back-office operation, said John Harvey, a managing principal with Capco, a New York firm that designs risk-management procedures for major financial institutions.

After a trader completes a transaction, the back-office staff confirms the trades by phone and also reconciles cash accounts at the end of each day. A bank's risk-management team would be busy making sure traders stay within their trading limits.

If an Allfirst trader documented a fictitious option contract, as bank officials allege, the bank's back-office staff should have discovered a discrepancy on the books, Harvey said.

Most banks have a mandatory "holiday" rule that requires traders to periodically take a break from trading for at least several days, Thorpe said, allowing irregularities to emerge.

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