Signs of Allfirst fraud were there in abundance but nobody noticed

ANALYSIS: The unfortunate story of Mr Rusnak's fraud came as a result of numerous deficiencies in the control environment at Allfirst treasury. The report by Eugene Ludwig on the Allfirst affair outlines a catalogue of risk control and supervision deficiencies

The Ludwig report is not the end of the $691 million (€783 million) fraud story for AIB. Mr Eugene Ludwig, the banker hired by AIB to investigate the fraud at the Allfirst subsidiary, confirmed this when he said his report should be seen as "preliminary, because significant leads remain to be pursued".

His 30-day investigation had to be completed without access to alleged rogue trader Mr John Rusnak, who refused to be interviewed, or to the foreign exchange traders he dealt with.

The investigation focused primarily on the Allfirst treasury operation. While Mr Ludwig believed 30 days was an inadequate time in which to produce a comprehensive report, he said he believed his report was "complete on the fundamentals".

"I am confident we understand the fundamental elements of the fraud and why it was not detected earlier," he said.

But in his report he appeared to hedge his position. He said: "Although we have confidence in our preliminary conclusions, it is likely that further inquiry will uncover additional material information or provide further clarification and insight. . ."

This additional information should come from investigations under way by US banking regulator the Federal Reserve Bank, Maryland state banking regulator, the US attorney's office, the Securities and Exchange Commission, and the FBI.

The report has disclosed two instances when senior AIB executives were alerted to suggested large volume trading at Allfirst but the information failed to lead to the detection of the fraud. It is not known if both alerts were ever considered in tandem.

In March 2000, group treasurer Mr Pat Ryan received an inquiry from Citibank about a $1 billion gross monthly settlement at Allfirst.

In May 2001, chief executive Mr Michael Buckley learned of suggestions of large volume trading at the US bank.

Explaining his handling of the "low level" market information he received, Mr Buckley said he telephoned Allfirst treasurer Mr David Cronin and got a vigorous and forceful denial of any problem.

"I believed the matter was closed and did not follow it further," he said.

Mr Cronin's reply to Mr Buckley was categorical but it "was also wrong", Mr Ludwig said. But in a follow-up e-mail response to Mr Buckley included in the Ludwig report, Mr Cronin's assertion that there were no unusual or extra large transactions appeared to be confined to trading in "the last two weeks with counterparties locally or in London". At that time Mr Cronin said the daily average turnover was $159 million. Mr Ludwig said it was at least three to four times this level.

The fundamentals, as identified by the Ludwig investigation, make very salutary reading for AIB chairman Mr Lochlann Quinn and Mr Buckley. While it identified a carefully planned and meticulously implemented fraud by Mr Rusnak over a lengthy period in which controls at Allfirst were circumvented and documents were falsified, it found that Mr Rusnak's trading activities were not properly monitored and supervised, and that the risks he was exposing the bank to were not appreciated at AIB Group and Allfirst levels.

"Even in the absence of any sign of fraudulent conduct, the mere scope of Mr Rusnak's trading activities and the size of the position he was talking warranted a much closer risk-management review," the report said.

The report shows the heavy reliance placed by AIB Group on Mr Cronin who moved to Allfirst in 1989. "A reliance that in hindsight proved misplaced," according to Mr Buckley.

But indicating some divergence of opinion on Mr Cronin between Dublin and Baltimore, the report said: "Even though Allfirst's senior management continued to believe in the treasurer's competence, over time Allfirst's management had increasing problems with his performance". It said that then chief executive and later chairman Mr Frank Bramble reported that on several occasions he had asked for changes so that Mr Cronin could be better supervised or that he be removed. It said "senior officers of AIB" recognised Mr Cronin's "levels of energy and commitment were lower than expected" but they believed he was the best person for the job given the limited treasury experience at Allfirst and because his presence helped to maintain the flow of information from Baltimore to Dublin.

Very basic control and risk management procedures were not applied at Allfirst.

"The unfortunate story of Mr Rusnak's fraud came as a result of numerous deficiencies in the control environment at Allfirst treasury. No single deficiency can be said to have caused the entire loss," according to the report.

Outlining the saga of control deficiencies, the report cited the failure to get back-office confirmation of all trades as the most critical - this should have picked up the bogus option trades with Asian counterparts. Other serious lapses included the failure to get foreign exchange rates from independent sources - the system used allowed Mr Rusnak to manipulate that data going through to the Allfirst middle and back offices. And the report pointed out deficiencies in the internal audit, treasury risk control and credit risk review areas.

It referred to inadequate staffing, lack of experience and too little focus on foreign exchange trading at the Allfirst internal audit. Inadequate and inexperienced staffing was a problem too in the risk assessment department and treasury risk control area.

The report found that senior management in Baltimore and Dublin did not focus sufficient attention on the Allfirst proprietary trading operation. The fraud would have been detected earlier but for the failure of Mr Rusnak's superiors to adequately supervise his activities, his positions and his trades, with options apparently expiring unexercised the day they were purchased providing an early clue.

According to the Ludwig report these transactions "were not merely suspicious but nonsensical".

Rudimentary checks such as taping his telephone calls were not in place and on the holidays he was required to take he continued to trade from his laptop. His daily profit and loss figures were not examined and reconciled with the bank ledger - if they had been, questions would have had to be asked because of the wide swings in his trading results.

Where questions were raised about Mr Rusnak's trading, the responses were inadequate, according to the report. It cited prime brokerage account issues such as the "irregular practice" Mr Rusnak asked his back office to perform of "controlled settlements" - withholding payment on trades to eliminate settlement risk, and back-office inability to get confirmation for some transactions.

"Difficulties confirming Mr Rusnak's trades were a regular phenomenon for the back office" , according to the report. Sometimes when questioned he would produce a confirmation that did not match the trade concerned. An SEC filing as well as inquiries from Citibank should have alerted AIB to the size of Mr Rusnak's trading.