Parent trawls through evidence at Allfirst to find out how and why

Michael Buckley will need to do a lot more than express confidence about the state of compliance and controls throughout AIB group to restore market confidence, writes Mary Canniffe, Investment Editor

AIB is still working out the "how" and "why" behind the spectacular loss of $750 million (€864 million) at its US Allfirst operation, according to chief executive Mr Michael Buckley. While the details of what happened and why at the Alfirst treasury division will only emerge in time, what is clear is that the bank's internal supervision and control procedures failed to protect the group from significant losses.

Attributed to the fraudulent actions of a trader working in the Allfirst treasury division, the extent of the losses has baffled most banking sources, given the relatively small size of the Allfirst treasury operation. AIB says a complex and determined fraud was perpetrated by a foreign exchange trader, Mr John Rusnak, at Allfirst. The bank cannot yet say if or to what extent the dealer or other individuals benefited personally from the fraud. But it says it is "comfortable" that its estimated loss of $750 million is accurate and has taken action to hedge against any unexpired contracts of the dealer involved.

AIB insists the fraud was confined to its Allfirst subsidiary and says possible collusion, internally at Allfirst and involving external parties, is under investigation. The trader involved has disappeared and is sought by the FBI, five Allfirst staff have been suspended and the bank has stopped Allfirst trading foreign exchange on its own account. This looks like closing the stable door after the horse has bolted.

Mr Rusnak has worked for Allfirst for seven years. Over the past year, this low-level bank employee appears to have fooled the bank's internal systems by entering bogus foreign exchange options contracts into its computer system. He entered into foreign exchange trading contracts and was buying and selling foreign currencies - understood to be mainly dollar/yen transactions on the spot (at today's price) and forward markets (at a future price).

In normal foreign exchange rooms, where dealers buy and sell currencies, they often hedge against possible profits and losses on these contracts by doing matching options contracts. Put and call options give the holders the right to sell or buy a currency in the future at a price agreed today. At Allfirst, it appears many options contracts recorded in the bank's systems by the dealer were fictitious. The dealer then had buy and sell foreign exchange contracts which were generating losses, and fictitious option contracts, which were masking these losses.

OPTIONS the bank thought were in place to protect against losses on foreign exchange positions were not there. Because these options were not in place, the dealer needed more and more cash to fund the losses on his currency contracts as they fell due. This increasing demand for cash was what eventually alerted his superiors to possible problems in his trading account.

While determined fraud, especially if internal or external collusion is involved, is difficult to protect against, the debacle raises questions about the Allfirst risk management procedures and controls. Mr Buckley will need to do a lot more than express confidence about the state of compliance and controls throughout the group to restore market confidence.

The market has been taken aback by the scale of the losses at a small dealing room. How could the dealer, over a 12-month period, enter on the bank's computer accounting system a series of complex but fictitious transactions? Why did the large volume - 60 to 100 trades per day - and the apparent complexity of his dealings not give rise to concerns about his activities much sooner? Why did Allfirst's internal auditors fail to notice the fraud when they checked contract documentation over the last 13 months? Why was the individual involved still trading up to early January?

It was only in the "last few weeks" that his supervisors appear to have started to investigate the dealer's trades when, according to Mr Buckley, the bank's internal controls were triggered by the increasing amount of cash needed by this one dealer to square losses on his positions. These weeks have been spent trying to distinguish between his real and unreal trades to determine the extent of the bank's exposure to losses. Over this period, Mr Rusnak was questioned by his treasury bosses, and the named counterparties to his deals were asked whether any deals had actually taken place.

Banks have checks and balances and internal control procedures in trading rooms. Dealers' activities are monitored daily and they must keep within intraday and end of day or closing trading limits, which set caps on the size of their exposures and trading volumes. Daily valuations of their net market risks are produced. Dealer calls are recorded and fax or telex evidence of trades are needed. Documentation seems to have been falsified at Allfirst, which suggests the trader may not have been operating on his own.

A team from AIB headquarters is trawling through the evidence at Allfirst, where procedures seem to have been overridden. For AIB and others, the key will be to ensure this cannot happen again. But, as Mr Buckley says, even where you put a sophisticated alarm system in place, it is difficult to protect against a sophisticated burglar.