Allfirst scandal laid at feet of bank's auditors

Internal workers should have seen the flags, critics say

3 signs went unheeded

February 23, 2002|By Bill Atkinson | Bill Atkinson,SUN STAFF

Allfirst Financial Inc.'s internal auditors failed to recognize or ignored key warning signs that could have prevented a currency trading scheme that went undetected for five years as losses mounted until they reached nearly $700 million, experts said.

One of the areas in the bank's on-going investigation is the role that its internal auditors played and how they missed uncovering the activity for so many years.

"How does somebody miss that?" asked Steven Jameson, director of technical services at the Institute of Internal Auditors. "It sounds to me like somebody was not looking at the reports, the monitoring system, the controls. It sounds like somebody wasn't doing their job."

At least three signs should have triggered alarms and forced the auditors to become suspicious, industry experts said:

Currency trading, for big and small banks alike, is considered an automatic hot spot that can easily trigger problems, and Allfirst's internal auditors should have known to keep the operation under scrutiny.

The volume of trading at Allfirst was unusually large for a bank its size.

The dollar amount fluctuated wildly and spiked significantly in the last three years.

"In my opinion, there are a hell of a lot of red flags there," said Boris F. Melnikoff, a banking consultant and money-laundering and bank-fraud expert in Atlanta, Ga. "Why didn't the auditor catch it? When you look at assets and you look at the rest of the activity, how can something be that far out of whack? Percentage-wise, it can't."

Auditors are under the microscope in the wake of several high-profile bankruptcies, most notably, Arthur Andersen LLP in the wake of the collapse of Enron Corp., the largest bankruptcy in U.S. history.

Allfirst, the U.S. subsidiary of Dublin, Ireland-based Allied Irish Banks PLC, revealed more than two weeks ago that currency trader John M. Rusnak, 37, of Baltimore, ran a scheme that caused $691.2 million in losses.

Allfirst became suspicious of Rusnak in late January after questioning the trading risks he was taking. Bank executives have said that foreign exchange losses soared as Rusnak gambled that the Japanese yen would rise in value. When the yen actually plunged, the bank claims, he hid the losses by creating fictitious option trades and by overriding internal systems designed to detect irregularities.

This week, Allied Irish said that an internal investigation found that the currency trading losses date back five years, forcing the bank to restate earnings through 1997.

Rusnak is cooperating with federal authorities in the investigation by providing details of how Allfirst's foreign exchange unit worked, sources close to the investigation have said.

State and federal examiners are combing through the bank's records, and Allfirst's internal investigation is being headed by Eugene A. Ludwig, a former top U.S. banking regulator. He is expected to release a report to Allied Irish's board March 9.

Like many large banks, Allfirst has its own internal audit team of about 30 people. They focus on the bank's controls and procedures, and work closely with its outside auditor, PricewaterhouseCoopers.

Both Allfirst and the accounting firm declined yesterday to comment.

There is no evidence, though, that either the bank's internal auditors or those from PricewaterhouseCoopers raised concerns about the currency trading operation. Had they, experts said, the scheme could not have dragged on undetected for five years.

There were enough signs to worry auditors, those experts added.

First, auditors should have been alerted by the volume of foreign currency trading at Allfirst because it was high for a bank of its size. Allfirst had $4.96 billion worth of foreign currency derivatives on its books, an amount equal to 28 percent of its assets as of Sept. 30 last year, the most recent figures available.

That's nearly triple the average of derivatives to assets for Allfirst's peer banks, said Kathleen Shanley, a debt analyst for Gimme Credit Finance, a debt analysis firm.

Further, Allfirst had foreign currency holdings of $2.2 billion on Sept. 30, 1998. A year later, it more than doubled, jumping to $5.2 billion. By September 2000, it had surged to $9.5 billion, according to federal banking regulatory documents.

Those increases show the growing importance of the foreign currency business at Allfirst and should have been closely monitored, said Richard Bove, a managing director with Hoefer & Arnett Inc. in Tampa, Fla.

"A trading area would be high on a public accountant's risk dashboard," Jameson said. "The volume of activity and the amount of exposure would have been bigger factors than the bottom-line profit."

Once the internal auditors missed the scheme, there was virtually no chance that anyone else would uncover it until the losses had reached hundreds of millions of dollars.

Outside auditors such as PricewaterhouseCoopers once dug deeply into all areas of a bank's operations. Today, they usually rely on the work of internal auditors and conduct only limited tests themselves. That increases the chances that fraudulent activities might slip by, industry experts said.

"The auditors would do a surprise audit on a branch, and they would go from stem to stern," Melnikoff said. "That seems to have passed by the wayside."

Outside auditors are satisfied with the bank's internal staff conducting a "self-audit," he said.

"If it balances, that is fine. We walk away fat, dumb and happy and we report back to the board," Melnikoff said. "What the auditors ... today are looking at is whether the overall procedures and policies are being followed. If the answer is yes, everything is fine, we don't have a problem - that is where I think the problem lies."

Sun staff writer William Patalon III contributed to this article.

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