Financial Management
Allied Irish Bank
On February 6, 2002, Allied Irish Banks - Ireland's second-biggest bank - revealed that it was
investigating an apparent currency fraud at its Baltimore-based subsidiary, Allfirst, perpetrated by a
trader named John Rusnak. It soon became clear that the scale and nature of the losses would make the
AIB/Allfirst story one of the biggest 'rogue trader' scandals since Nick Leeson brought down Barings bank
in 1995. It was Ireland’s biggest banking scandal and the fourth largest banking scandal in the world.
The AIB board of directors quickly commisioned an independent report to identify the problem.
Written by the Eugene Ludwig, a former US Comptroller of the currency, the report concluded that
Rusnak had systematically falsified bank records and documents and had been able to exploit weak
control environment at Allfirst’s treasury.
The central findings of the report said that AIB rogue trader had allegedly accrued losses by writing non
existent options and booking the fictitious premiums from them as revenue. The motive according to
the report, was to recoup money which Rusnak had lost, sometime in 1997, on a misplaced trading
strategy. The Ludwig report suggests that Rusnak used currency forwards to take a position on the
movement of Japanese Yen. The situation was further complexed when he started to sell a number of
Deep-in-the-money options to counterparties for high premiums, racking up huge unrecorded liabilities
for the bank. He created fictitious option positions in order to hide his losses which gave the impression
that his real position was hedged.
Rusnak's technique was apparently to enter two bogus options trades into Allfirst's trading system
simultaneously. These purported trades involved no net cost to the bank, because the first option
involved receipt of a large premium and the second involved paying out an identical premium. But the
first option would expire on the same day it was written, while the other option would not expire for
several weeks.
The result was that fake assets were created on Allfirst's books without the bank having to pay for them,
and these 'offset' certain real, losing positions in the forex markets. It made no sense for a deep in-the-
money option (the option involving receipt of a large premium) to expire without being exercised by the
counterparty, since this would be an extremely lucrative transaction for the option buyer .
Another factor of this scandal was the failure of the back office to obtain transactions confirmations
consistently. Upto Sep 1998, fictitious deals were validated by the help of bogus broker confirmations.
But from then on, the report says, Rusnak managed to persuade the Allfirst back office that the option
pairs do not need to be confirmed, since they were offsetting deals with no net transfer of cash. As each
bogus option expired, it was rolled over into new bogus options.
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Financial Management
In his real trading on the spot and forward markets, Rusnak was still losing money. Much of his loss-
making trading was carried out under net settlement and, later, prime brokerage accounts with Bank of
America (BofA) and Citibank. Under these arrangements, the spot transactions between Allfirst and its
counterparties were settled with the broker and rolled into a forward transaction, then swapped each
day into a forward forex trade between Allfirst and its prime broker.
These forward trades were settled in cash on a fixed date each month. The report says: "These accounts
enabled Mr Rusnak to increase significantly the size and scope of his real trading. It effectively permitted
Allfirst to make trades in the prime brokers' names, and it effectively made the prime brokers the back
office for those trades." Rusnak's trading grew through his use of prime brokerage accounts, as did his
losses - and so, inevitably, did his bogus options positions.
When Allfirst decided in 2000 that trading income should reflect a charge for the cost of balance-sheet
usage, it quickly became clear that Rusnak's trading was using an inordinately large proportion of the
balance sheet. In January 2001, head of treasury funds management Robert Ray noticed that Rusnak's
use of the balance sheet was much greater than warranted by the size of his earnings, and ordered him
to scale back his use of the balance sheet.
This left Rusnak in need of an alternative source of funds, and from February 2001 the Ludwig report
says that he turned to selling year-long, deep-in-the-money options - real ones, this time, rather than
bogus ones. Since these were extremely attractive to buyers, they were able to command very high
premiums (he sold five such options for a total of $300 million) but the result was that Allfirst was
saddled with massive potential liabilities. Rusnak's use of the Allfirst balance sheet declined as a result of
his use of these options to fund his activities, but Allfirst treasurer David Cronin was still concerned
about it and ordered him to reduce his usage by the end of 2001.
Allfirst's true trading position was finally uncovered when a back-office supervisor discovered that the
supposedly offsetting options deals were not being properly confirmed. The supervisor directed the
back-office employee involved to confirm all future similar trades.
Meanwhile, Cronin was disturbed to find that although Rusnak's use of the balance sheet had fallen to
$150 million by the end of 2001 as directed, it had spiked to more than $200 million in one day in
January.
From this point on, events unfolded quickly. Rusnak failed to appear for work on Monday, February 4 -
after a weekend when Allfirst's back-office staff were unable to confirm his trades with his supposed
counterparties in Asia. Cronin reported the problems to Allfirst's senior management. They, in turn,
informed AIB in Dublin.
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