Bank Accuses U.S. Trader of Losing $750 Million
Ireland’s biggest bank said Wednesday that a rogue employee involved in currency trading secretly lost $750 million at its U.S. subsidiary, jolting the European markets and triggering a federal criminal investigation into another financial debacle.
The suspected fraud at Allied Irish Banks’ Baltimore-based subsidiary, Allfirst Bank, would be one of the biggest trading scandals since Singapore dealer Nick Leeson brought down Britain’s Barings Bank in 1995 after piling up $1.4 billion in concealed losses.
Allied Irish said John Rusnak, a 37-year-old employee who was well-regarded in his seven years at the bank, ran up the losses over the course of last year at Allfirst Bank, where he was part of a small but aggressive currency trading operation.
As federal authorities launched a criminal investigation, Allied Irish suspended five Allfirst employees including Rusnak, saying he may have colluded with other employees and outsiders. The bank said the trader had created bogus option contracts that were supposed to insure against trading losses but in fact concealed them.
“It’s really a fraud,” Allfirst Bank spokesman Philip Hosmer said. In calling in the FBI, executives were “absolutely looking at collusion, internal and external,” Hosmer said. “That’s a big part of the investigation.”
Rusnak has not been charged with any crime. His attorney, Bruce Lamdin, declined to answer when asked if Rusnak had profited from any trading irregularities. Lamdin said he believed that the bank’s losses are being “grossly exaggerated” and suggested Allied Irish is trying to isolate itself from blame.
No customers lost money and the bank remains well-capitalized, with no chance of collapsing, bank officials and regulators said. Allfirst is the nation’s 44th largest bank holding company with $17.8 billion in assets and more than 250 branches in the East Coast.
The news sent financial stocks tumbling, with Allied Irish down 16%, its steepest decline in 12 years. Amid ongoing revelations of wrongdoing at Enron Corp., the bankrupt energy trader that overstated earnings by $1.3 billion, the case raised more disconcerting questions about the financial oversight exercised by companies, their auditors and regulators.
“There was clearly a horrible breakdown of internal controls here,” said Bert Ely, a banking consultant in Alexandria, Va., who was involved in sorting out many of the failures in the savings and loan industry a decade ago.
An Allfirst spokesman said an internal audit turned up discrepancies last week in accounts handled by Rusnak. The bank said he was suspended after failing to answer questions or report to work since Monday.
Lamdin said Rusnak spent much of Wednesday talking with federal prosecutors and returned to his wife and two children, ages 6 and 8, for the night.
Lamdin, who said he and co-counsel David Irwin had spent just three hours debriefing Rusnak, wouldn’t discuss the case in detail, saying the facts are still unclear.
Agents from the Federal Reserve Board joined the FBI and other federal authorities in investigating Allfirst. Fed spokesman David Skidmore said the agency is working closely with the Irish Central Bank, that country’s main banking regulator.
An official at the U.S. attorney’s office in Baltimore said investigators have found no indication that Rusnak attempted to steal money, though he could still face federal fraud charges for manipulating financial records.
“What it looks like is that he [Rusnak] made some bad trades and did some things he shouldn’t have to hide what he’d done,” said the official, speaking on condition of anonymity.
Asked why Rusnak would fake trades to cover up losses, Allied Irish Treasurer Pat Ryan said “some people do it for personal gain, some people do it because it’s a pride issue [and because] they’re unable to own up to a mistake. Many can start with a small mistake and the thing snowballs.”
Lamdin described Rusnak, who the bank said earned $85,000 a year, as “just an ordinary guy in a volatile job, one that not many people can do.”
Raised in a working-class suburb of Philadelphia, Rusnak left a high-pressure job in New York to move to Baltimore, where he bought a house for $217,500 in 1994, according to acquaintances and records. An active Catholic with children in a parochial school, Rusnak was on the board of Baltimore Clayworks, a nonprofit ceramics center, but he skipped many meetings.
“He was always distracted by work. At least I assumed it was work,” said Margery Pozefsky, a board member. “He kept volunteering to solicit contributions from people in the banking industry, but he never really came through. I always got the feeling that he didn’t really have the connections to people that high up.”
Major banks such as Allfirst are the biggest players in the $1-trillion-a-day foreign currency trading market, which is largely unregulated worldwide. It has no central clearinghouse, like the New York Stock Exchange, and no central regulator, like the Securities and Exchange Commission.
Banks trade currencies partly to make a profit and partly to help their international corporate customers, though customer money isn’t usually at risk. The trading that goes on over electronic systems establishes the daily exchange rate that individuals and corporations use in trading, say, euro dollars for U.S. dollars.
Banks typically aim for incremental profits, made in a matter of minutes or hours, not days or weeks, said analyst Elvis Picardo at Global Securities Corp. in Vancouver.
“Not many people know what goes on behind the scenes,” said Picardo, a former currency trader in India. “You very seldom get a breakdown from banks on how much foreign currency trading they’re doing. It’s an extremely volatile market, and has the potential for large losses.”
Allfirst Bank’s parent company, Allfirst Financial, for instance, lists “trading income” of $5.1 million for the third quarter last year but never explains whether that came only from the currency market. The income represents about 5% of its noninterest income and 10% of net income.
The bank’s income from trading doesn’t sound like much, Picardo said, but “a $750-million loss is an enormous chunk.”
With concerns raised over financial disclosures stemming from the collapses of Enron and other major companies, regulators might try to turn the light on foreign currency trading operations at banks. “The area definitely needs more disclosure,” Picardo said.
Hosmer, the bank spokesman, said Rusnak disabled internal controls designed to prevent such a fraud, but bank officials began asking questions last week when an employee noticed something irregular about the foreign currency trading desk.
By late Sunday, Hosmer said, the bank launched an investigation. What they found, he said, were the bogus options that were supposed to be a hedge against trading losses.
The way it was supposed to work was for the bank to trade, say, $50 million in U.S. currency for Japanese yen on the belief that the yen would rise against the dollar, giving the bank a profit when it sold the yen. As insurance against losses on the bet, the bank would pay for an option to buy U.S. dollars in case the yen fell instead. Such hedges are designed to lessen or eliminate any losses.
But what Allfirst executives found was that the option contracts entered into the bank’s system were bogus, Hosmer said. That meant that $750 million in trading losses over the last year or so weren’t covered.
The loss will have a major impact on the bank’s earnings last year, which were $149.5 million for the first nine months, and the company may well have to restate earnings for prior periods. It also will lower key capital ratios that banking regulators use to assess the strength of financial institutions.
Even taking such a hit, Allfirst will remain well above the mark for well-capitalized banks, analysts said. But the Standard & Poors rating agency placed Allfirst Bank, Allfirst Financial and Allied Irish Banks on credit watch with the implication that the solid A and A+ ratings on its debt securities may be lowered.
Investors punished Allied Irish’s stock. In London, Allied Irish shares plunged 15%. In the United States, Allied Irish Banks’ American depositary receipts fell $3.78 each, closing at $19.77 per ADR.
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The Baltimore Sun contributed to this report.
