PROFILE: Rusnak was seen as an active trader and a profitable client for brokers. He was only four days away from his largest-ever bonus when the fraud was discovered Colm Keena

The trading manager to whom Mr John Rusnak reported in Allfirst bank was not replaced when he left in 1999, in part for budgetary reasons, according to the report.

Following the executive's departure, Mr Rusnak began reporting directly to Mr Bob Ray, the treasury funds manager who had hired Mr Rusnak in July 1993. Mr Ray hired Mr Rusnak on the recommendation of a friend who had worked with him at another bank.

Allfirst had up to then engaged in simple currency bets but Mr Rusnak promoted himself as someone who attempted more complicated trades.

"Messrs [Allfirst treasurer David\] Cronin and Ray were intrigued by Mr Rusnak's style of trading," according to the report.

However, Mr Ray had limited knowledge of foreign exchange and appeared not to devote significant attention to Mr Rusnak's proprietary trading (trading for the bank as against for customers). Mr Ray "apparently did not increase his focus on that trading even after the trading manager's departure".

Mr Cronin, despite his extensive currency-trading experience, "relied heavily" upon Mr Ray to supervise Mr Rusnak.

"The treasury funds manager [Mr Ray\] was highly protective of Mr Rusnak; he often strongly defended Mr Rusnak in inquiries by the back office and risk assessment personnel, and even went so far as to attempt to direct the risk assessment group to forward all inquiries regarding Mr Rusnak's trading activities to him instead of to Mr Rusnak."

Mr Rusnak was paid a bonus equal to 30 per cent of net trading profits in excess of five times his salary. Between 1997 (when he received no bonus) and 2000 he was paid total bonuses of $328,543 (€374,323).

This was on top of his annual salary of a little more than $100,000. He was four days away from getting a 2001 bonus of $220,456 - his largest ever - when the fraud was discovered.

According to the report, Mr Rusnak appeared to be living a lifestyle consistent with his income. In the market, Mr Rusnak was seen as an active trader and a profitable client for brokers.

"The brokers and traders heavily entertained Mr Rusnak, with meals, hotel stays, golf trips, Super Bowl tickets and other travel. He apparently liked to be wined and dined, and the brokers obliged."

While Mr Rusnak was telling the bank that he was involved in an arbitrage (an exploitation of price differentials) between foreign exchange options and the spot and forward markets, he was mostly involved in straightforward bets on how exchange rates would move in the future.

In or around 1997, he sustained substantial losses "and it was around that time that his fraudulent activities may have begun". Mr Rusnak lost on a bet as to how the yen would move against the dollar.

He began to hide his losses by creating fictitious options (contracts to buy or sell at a later date). He then found a clever way of getting these options onto the bank's books.

The trick involved buying options that mirrored each other (the asset equalling the liability) but with one side of the mirror being options that expired in one day.

A flaw in the bank's system meant these one-day options could slip past controls, so the liability they represented would not appear on the books. The other bogus option would appear in the books as an asset. These "assets" could then be used to mask the losses Mr Rusnak was making on real trades.

Mr Rusnak also apparently managed to persuade a back-office colleague not to seek to confirm the pairs of purported options that Mr Rusnak was pretending to take out, on the basis that there was no net transfer of cash.

The fact that confirming calls would have had to be made in the middle of the night to Asian institutions may have influenced the scenario.

As Mr Rusnak continued to lose money he wrote more and more bogus options.

"There were a few months in late 1999 when he apparently made some money back and reduced his bogus options positions but that was short lived," according to the report.

Net settlement arrangements he had with the banks he traded with evolved into prime brokerage accounts.

These involved the foreign exchange transactions being settled with a broker and rolled into a forward transaction. On a fixed date each month the two sides settled in cash.

This new arrangement allowed Mr Rusnak to increase significantly the size and scope of his real trading. Prime brokerage arrangements are unusual for banks but Mr Rusnak managed to convince his Allfirst supervisors that they made sense for the bank "because they would eliminate the need for extensive back-office operations".

Mr Rusnak's losses grew as his trading grew. So too did the bogus options positions he was taking out. However, an inquiry early in 2001 into Mr Rusnak's activities led to restrictions on his access to the bank's cash.

"With this change, Mr Rusnak needed a new source of funds."

Starting in February 2001, Mr Rusnak began selling real year-long, deep-in-the-money options. He sold five such options for $300 million.

In effect, these were massive bets at long odds that the counterparties paid to get into because they stood to make profits. Mr Rusnak used the money raised to make further currency bets.

While doing some of these deals, Mr Rusnak actually explained to his counterparties that he needed money so he could trade.

"I have come to you with a problem, we need to outsource our balance sheet funding," he told one counterparty.

These deals were liabilities on the books of Allfirst. To get them off the books, Mr Rusnak created bogus matching options with the same counterparties, which had the effect of apparently neutralising what were real liabilities.

Allfirst had in place sophisticated software that could calculate the risk to the bank of the positions Mr Rusnak was taking in the currency markets. However, Mr Rusnak manipulated the system through his creation of bogus options and by simply generating false information on his personal computer, which he then supplied for the model used. The truth behind the information he was providing from his computer - the creation of bogus "holdovers" - would have been spotted by a simple check.

"The fraud was so inelegant that on some occasions Mr Rusnak would leave the same holdover position running for three straight days. No one caught it."

This bit of deceit undermined Allfirst's prime measure for monitoring trading. The bank's system indicated he was rarely exceeding the $1.55 million risk limit that he had been allocated.