CONTROLS: The failure of the back office to confirm all trades - standard practice in the industry - was the most critical risk-control lapse, according to Ludwig report

Mr John Rusnak's fraud came about because of numerous deficiencies in the control environment at Allfirst's treasury, the Ludwig report found. No single deficiency could be said to have caused the entire loss but together they allowed it to happen.

The report describes the failure of the back office to confirm all trades, standard practice in the industry, as the most critical risk-control lapse.

"Mr Rusnak was somehow able to bully or to cajole the operations staffer responsible for confirming Mr Rusnak's trades into not confirming all of them," the report said.

It speculated that perhaps this suited the back-office staffer as many of the bogus options were purportedly with the Tokyo or Singapore branches of major international financial institutions. "To have made confirming telephone calls would have required the employee to work in the middle of the night," the report noted.

As a result, the bogus options contracts Mr Rusnak was putting on Allfirst's books were not checked with the supposed Asian counterparties and were, therefore, not detected.

The report also criticises the failure of the middle and back offices to obtain foreign exchange rates from an independent source to independently revalue his trades.

At one point, a system was developed where rates were downloaded from Mr Rusnak's Reuters terminal to his personal computer, then fed into the shared network to make them accessible to the rest of the office. A risk-assessment analyst responsible for treasury, while undertaking a quarterly review, noted that this was a failed procedure as technically the trader could manipulate the rates.

When she asked why the rates could not be obtained independently, she was told Allfirst would not pay for a $10,000 (€11,330) data feed from Reuters to the back office.

At a further review of the foreign exchange pricing spreadsheet, the analyst discovered it was corrupt. The cells for the yen and the euro, the two currencies in which Mr Rusnak traded most, had links to his computer that detoured outside of Reuters.

However, it was 14 months after the risk assessment analyst discovered the source of daily foreign exchange rates was not independent, and around six months after she discovered that the rate spreadsheet was corrupt, before Allfirst remedied the problem.

The report noted, despite the discovery that Mr Rusnak could have been manipulating prices, there was no attempt to examine if he had been doing so.

Investigation by AIB trading experts has since revealed that he had engaged in price manipulation and only stopped in April 2001, around the time risk assessment obtained a copy of the pricing spreadsheet he had corrupted.

The report also found deficiencies in internal audit as well as in the treasury risk control and credit risk review areas. In 1999, an internal audit of treasury operations undertook no sample of Mr Rusnak's transactions to see if they had been properly confirmed.

In August 2000, 25 transactions were sampled to see if they had been properly confirmed but only one of these was a foreign exchange option, which turned out to be genuine. Yet around half of the 63 foreign exchange options on the books at the time were bogus.

Had the auditors included just one more option in their check, they would have increased the probability of finding a bogus one to around 75 per cent. The report also found that internal audit suffered from "inadequate staffing, lack of experience and too little focus on foreign exchange trading as a risk area".

Just two full-time auditors were devoted, at most, to auditing all of treasury and, in recent years, neither had a background or training in trading activities, let alone foreign exchange.

The entire risk assessment department only amounted to two people who were responsible for assessing risk company-wide at Allfirst, the report said.

Those responsible also failed to investigate the frequent instances where Mr Rusnak exceeded the credit limits set for foreign exchange trading.

Both the treasury risk control and credit risk review offices were made aware that he had breached by $86 million the $100 million foreign exchange credit line that AIB and Allfirst had set for UBS.

The overshoot was simply attributed to "trader error" in the report on it. "Neither the middle office nor the credit group questioned why Mr Rusnak had incurred an exposure to UBS as large as $186 million. Nor did they raise flags as similar instances of substantial 'trader errors' piled up over the rest of that year," the report said.

Interviews revealed that neither office considered itself responsible for investigating such excesses.

"Each believed it was the other's job to analyse credit limit overages; each believed its own role was merely to report them," Mr Ludwig found.