Academic journal article ABA Banking Journal

Their Pain, Your Gain: Allfirst's Very Public, and Large, Currency Trading Fraud Loss Offers Many Lessons for Other Banks. (Risk Management)

Academic journal article ABA Banking Journal

Their Pain, Your Gain: Allfirst's Very Public, and Large, Currency Trading Fraud Loss Offers Many Lessons for Other Banks. (Risk Management)

Article excerpt

John M. Rusnak turned out to be the foreign exchange trader who couldn't shoot straight.

Sometime in 1997, Rusnak took a view that the U.S. dollar would fall against the Japanese yen-a conviction that turned out to have disastrous consequences for his employer, Baltimore-based Allfirst Financial Corp. Using currency forwards, Rusnak bought yen for future delivery only to see the currency fall against the greenback, racking up a couple of million of dollars in losses.

"You couldn't have picked a worse time to bet against the dollar," says Duncan Hennes, a partner at Promontory Financial Group in Washington.

Rusnak did have one uncommon talent: He proved to be particularly adept at hiding his bad trades. Over the next four years, as his trading setbacks continued, Rusnak managed to hide his ballooning losses through an elaborate and brazen fraud. He wasn't caught until December 2001, at which point his losses had reached an astounding $691.2 million. Hennes, one of a team of consultants and lawyers who investigated Rusnak's activities for Allfirst's corporate parent, Dublin-based Allied Irish Banks PLC, describes him as "devious and clever" and says, "This guy was a genius.

This may be giving Rusnak more credit than he deserves, because his true skill was in exploiting a risk control process at Allfirst that was highly dysfunctional. Not only was Allfirst's risk management process flawed in certain key respects, but a troubling lack of punctiliousness from Rusnak's bosses on down allowed his fraud to go undetected for as long as it did. "This is a case where a lot of little things, little checks and balances, didn't get done," says Promontory's managing partner, Eugene A. Ludwig, a former comptroller of the currency.

A public airing of mistakes

There are a variety of lessons to be learned from Allfirst's trading debacle, but none more crucial than the importance of a strong risk management process. Enough mistakes were made at Allfirst to fill a textbook of how not to oversee a trading desk. But many of those miscues occurred because the executives running Allfirst--all of whom have since left the bank-as well as AIB's executive management team in Dublin, never created a strong risk management culture at the U.S. subsidiary. "Strong and independent is key," says Fred Pennekamp, managing director for market risk at Wachovia Corp. "If you're missing either one of those, you aren't going to be effective."

Ludwig was brought in to investigate the Rusnak mess in February of this year when he received, as he puts it, a "phone call right out of the blue" from AIB Chairman Lochlann Quinn, whom he had never met. Quinn made it clear that he wanted a "real blue ribbon job" that would get to the bottom of the Rusnak scandal as quickly as possible. "AIB realized it had a problem and had to deal with it in a very systematic way," says Ludwig, who was assisted in his investigation by the New York law firm Wachtell, Lipton, Rosen and Katz. The Irish bank later made Ludwig's 57-page report public-even going so far as to post it on the Allfirst website.

The Rusnak affair turned out to be a disaster for AIB. The trading losses reduced its net income in 2001 by more than $500 million, and senior AIB executives said earlier this year they might sell the bank. The Irish bank did lust that in late September when it turned Allfirst over to Buffalo, N.Y.-based M&T Bank Corp. in a deal valued at $3.1 billion. AIB will receive a 22.5% stake in M&T along with $886 million in cash. Wachtel, Lipton attorney Edward Herlihy, who represented AIB in the transaction, says Allfirst's below-average performance had already left executives back in Dublin disillusioned with the subsidiary. "They were going no place even before the Rusnak situation," he says. [For more about M&T, see ABABJ, Sept. 2002, p.50.]

Fallout at Allfirst has been extensive, as well. …

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