Allfirst Financial: Out of Control

By Sean Gallagher  |  Posted 2002-03-12 Email Print this article Print
 
 
 
 
 
 
 

Allfirst Financial ran its currency trading desk without much of the software that was standard at its corporate parent, Allied Irish Banks. Was that a $690 million mistake?

Baltimore's Mount Washington neighborhood is not a likely locale for an international banking scandal. But the narrow streets of this hilly upper-middle class enclave were jammed in the first week of February with TV remote trucks and British tabloid journalists standing vigil around one $232,020 home. The hope: John Rusnak, a currency trader at Baltimore's Allfirst Financial, would pop out of his hole like Punxsutawney Phil had four days earlier to see his shadow.

PDF Download But Rusnak wasn't at home. Nor, for that matter, was $691 million that was supposed to be in Allfirst's treasury. And the bank faced a lot more than six additional weeks of winter.

Even though Allfirst, the U.S. unit of Ireland's Allied Irish Banks (AIB), should have been able to prevent or flag unauthorized trading of this magnitude, it didn't. And the damage from bogus trades and secret accounts that Rusnak appears to have created is tangible. In a recent filing with the Securities and Exchange Commission, Allfirst warned it will have to re-submit annual financial statements going back to 1997. The loss effectively wipes out the company's net income for the past four years.

At the heart of the problem was the bank's system of currency trading controls. "It's very clear now that this guy targeted every control point of the system and systematically found ways around them, and built a web of concealment that was very sophisticated," AIB CEO Michael Buckley told reporters while discussing Allfirst's loss.

Allfirst won't say why they failed to detect such a long-running scam. But in this case, a single trader should not have been able to put more than $2.5 million of the bank's capital at risk. And if all trading had been electronic, no individual should have been able to hide losses.

The debacle is proof the global marketplace isn't electronic from end to end. And while AIB has deployed software that effectively tracks and controls the actions of its traders in its own offices around the world, Allfirst had implemented only a portion of that system. Not yet installed, for instance, is a program that would capture the specifics of currency trades electronically, and, one that would manage the confirmation of electronic trades, once executed. With only two employees including Rusnak on the currency-trading desk, Allfirst apparently didn't think the expense of full integration was warranted. And, AIB appears to have been happy with Allfirst's results.

In the company's annual financial statement for 2000, Allfirst crowed:

Trading income, before the effect of the cost to carry derivative assets on the balance sheet, increased by $6.6 million, due to growth in foreign exchange trading activities. Trading income (net of the cost to carry derivative assets) was $10.9 million in 2000 and $9.8 million in 1999.

That $10.9 million would have been the equivalent of 6% of Allfirst's net income for 2000. This, with a trading desk of two people.

Which seems to show Rusnak wasn't out to bankrupt his employer—he was out to make Allfirst a lot of money by taking big risks on the relationship between the values of the dollar and the Japanese yen, according to AIB executives.

Trading of currencies is broken down into two functional areas, the "front office" and "back office." The front office is the trading desk itself, where trades are made and recorded. The back office handles accounting and oversight—the confirmation of validity of trades, enforcement of internal controls (such as trading credit limits), the matching of trades with confirmations from the counter-parties (who the trade was executed with), trade fulfillment, and passing data on the positions taken by traders to managers and risk analysts.

This separation of responsibilities is key to the control of trades. When the two functions are blurred, the opportunity for a trader to "go rogue" rises exponentially. The greatest example: the 1995 case of Barings Bank. There, a single trader, Nicholas Leeson, lost nearly all the assets of the bank, amounting to $1.2 billion. "It was established after the fact that he had control over back office," says John Harvey, a managing principal at Capco, a financial systems consulting firm in New York. "The initial cause of [the Barings disaster] was due to lack of segregation."



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Sean Gallagher is editor of Ziff Davis Internet's enterprise verticals group. Previously, Gallagher was technology editor for Baseline, before joining Ziff Davis, he was editorial director of Fawcette Technical Publications' enterprise developer publications group, and the Labs managing editor of CMP's InformationWeek. A former naval officer and former systems integrator, Gallagher lives and works in Baltimore, Maryland.
 
 
 
 
 
 

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