Allfirst, trader could be headed for a showdown

THE BALTIMORE SUN

For nearly eight years, the interests of Allfirst Financial Inc. and John M. Rusnak were the same.

Rusnak traded currency, advancing his career and earning hefty annual bonuses. And Allfirst let him do it, pleased with its productive little fringe business.

But on Feb. 4, when Allfirst executives discovered that Rusnak had secretly lost $750 million, their interests diverged into a complex, Rusnak-vs.-Allfirst showdown that could play out in civil and criminal courtrooms.

For Rusnak, prison is the risk. For Allfirst, the stakes include a $200 million insurance policy, potential lawsuits from shareholders and a nagging scandal that continues to eat away at its image. And the outcome hinges on whether Rusnak or the bank is to blame.

"Everybody's interests are aligned, and everybody is trying to make money and do right by the investors until the point where Mr. Rusnak doesn't follow the internal rules," said Andrew C. White, a white-collar criminal defense lawyer in Baltimore. "The minute he ... disregards the internal controls, Mr. Rusnak and the bank's interests diverge."

Bank officials said that before Feb. 4, Rusnak was a model employee and an "upstanding member of his community." But since his trading losses were disclosed, Allfirst has accused Rusnak, publicly and often, of defrauding the bank and skirting its otherwise adequate safeguards.

"This was a very clever and sophisticated operation," the bank said in a message to customers. "This individual used his intimate knowledge of our business to manipulate our systems and to disarm our controls. This was fraud, not an accounting issue."

"Fraud" is a strong word, given that Rusnak hasn't been charged with a crime. But industry experts are not surprised to hear it, because fraud is precisely what Allfirst must prove to escape the debacle and reduce its losses.

Collecting on its $200 million insurance policy, for one thing, will hinge on Allfirst's ability to prove that its losses were caused by Rusnak and not by normal trading activity, sloppy oversight or collusion by other bank executives.

The details of Allfirst's insurance coverage, including the name of its insurance company, are proprietary and cannot be determined. The bank, for instance, might have coverage specifically to guard against the type of "rogue trading" that Rusnak is accused of. Company officials won't say.

But at a minimum, Allfirst's traders are bonded to protect the bank's assets against employee fraud - a requirement under federal banking regulations. According to The Financial Times, the bank's coverage is worth $200 million.

"It wouldn't protect them from trading losses or anything lost in the normal course of business, only from fraud," said Raymond LuBien, managing director of the Financial Institutions Insurance Association. "You can't insure against bad judgment or bad management."

In typical policies of that type, the bank would have six months to file a "proof of loss" - essentially, to make a case with the insurance company that a payout is deserved. Because of that deadline, the insurance case could play out long before any criminal charges reach a courtroom.

The bank must also show that Rusnak intended to cause the loss and that he did so for his own gain. That's where many "rogue trading" claims break down, experts say.

"That's not always easy to prove," said Andrew M. Reidy, a Washington attorney who specializes in corporate insurance claims. "Especially in the case of a rogue trader - the guy who goes in there making huge, unauthorized trades. He doesn't usually act to injure the bank; he's hoping everybody comes out on top."

Still, Reidy says, he expects that Allfirst executives are already deep into preparing their case.

Insurance isn't the only reason that Allfirst might want Rusnak painted as a defrauder, attorneys say. If Rusnak is the culprit, then Allfirst is also protected from claims from shareholders that the bank is guilty of fraud.

Some experts expect those shareholder lawsuits to be filed.

Two kinds of lawsuits

Experts say shareholders could file two kinds of lawsuits against the company.

For one, they could sue Allfirst's executives and directors on behalf of the corporation for the losses suffered. Going after the directors is never easy because the shareholders would have to show negligence, and directors are not typically involved in supervising bank employees.

"Really, the argument would be that the managers of the corporation were negligent to an extreme degree in supervising one of their employees," said Mark Sargent, dean of Villanova University's law school.

The bank would likely defend itself by demonstrating that adequate safeguards were in place and that the supervisors acted consistently with those safeguards, Sargent said. Allfirst has already made that argument publicly.

Shareholders could also allege that the bank knew about the losses and failed to warn investors promptly - and as a result, shareholders paid too high a price for the stock.

Banks have a common defense for that kind of lawsuit as well. "The bank would say, 'We weren't going to disclose tentative information, soft information in the marketplace until we knew the losses here,'" Sargent said.

Such lawsuits are typically filed when the stock price falls about 25 percent and stays at that level. Stock in Allfirst's parent corporation, Allied Irish Banks, fell 16 percent after the losses were announced but has recovered half that amount.

Robert Litt, a criminal attorney at Arnold & Porter in Washington, says he doesn't expect shareholder lawsuits. "In this case, you don't have victims who are shareholders," Litt said. "I don't see the potential for somebody to sue here; the only victim is the bank. No matter how I slice it, it is hard to see litigation coming out of this - other than criminal."

If Allfirst's losses produce a criminal case, it might affect only Rusnak, who has talked to the FBI. His lawyer has said that Rusnak took no money and that the losses are not as large as the bank claims.

Penalties for defrauding a bank carry a maximum of 30 years in prison and a $1 million fine, said White, the Baltimore attorney.

The Jett case

Some experts point to the case of Joseph Jett, the former Kidder Peabody & Co. bond trader, as a possible defense for Rusnak.

Jett was accused of booking $350 million in phony profits but was never charged criminally after arguing that "some higher-ups knew what he was doing," said Jay Ritter, a finance professor at the University of Florida.

"His defense ... was based on, 'I would get big bonuses if I made money, and my superiors would get big bonuses. That is why they were willing to cover things up. I wasn't a rogue employee doing this alone; my superiors were well aware of the scheme,'" Ritter said.

Regardless of the case's potential future in the courtroom, the battle between Allfirst and Rusnak is likely to continue for months and continue to make headlines.

That is not good for Allfirst's image, said Litt, the Arnold & Porter attorney, and is further motivation for the bank to avoid blame.

"Allfirst's interest here is trying to make this disappear from the public's mind as quickly as possible," he said. "I can't see any benefit to Allfirst seeing this story in the paper day after day. I would think their interest would be trying to get this off the front pages, off the back pages, off the middle pages as soon as they could."

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