Unauthorized FX Options Trades At ABN-AMRO Produce Significant Loss for New York Unit

ABN-Amro, the largest Dutch bank, uncovered a $30 million loss in its foreign exchange options book in New York last week and has suspended James Martigione, head of its New York options desk and at least one of his assistants, according to sources at the bank. The loss stems from one or more unauthorized options transactions.

"There has been a problem detected in the New York treasury operation," says Julie Wright, director of corporate communications for ABN-Amro in North America. "We think we have it under control now. It was uncovered in a routine check. There were unauthorized options transactions; their open position was closed."

Neither the precise amount of the loss nor the status of individual employees was confirmed by the bank. "We are taking a loss but it's not such a significant loss that we can't cover it in our ongoing results for treasury group in North America," says Wright. "In terms of ABN-Amro bank as a whole, it's a significant loss but not a major loss." The loss will depress fourth quarter earnings and could result in a management shakeup in New York.

The hit was the result of undetected out-of-the-money sterling call positions, according to sources close to the bank, and may spark the departure of Michael Guarino, head of the bank's foreign exchange trading operation in New York. Guarino did not return phone calls by press time.

This is the most serious hit the bank has ever taken in foreign exchange and its discovery sparked an internal audit that continued well into the weekend, sources close to the bank say. Aside from the options loss, the audit also turned up an outstanding $400 million spot sterling position, which has since been settled, the source adds.

After the positions were established, traders there intentionally falsified records, according to the source, in hopes of concealing their error. "Deal tickets were written incorrectly and trade details were put in the computer incorrectly," this source says. The bank's computer systems may have been used to obscure the loss.

Like many forex options trading units, ABN-Amro's New York FX options desk uses one system for front-office portfolio risk management and another group of systems for back-office risk management and treasury control. Since the front-office systems are not directly linked to the back-office systems, discrepancies may take time to surface.

In the case of ABN-Amro, the front-office risk management software used for foreign exchange options trading is Fenics, from New York-based Astrogamma Inc. At ABN-Amro's N.Y. options desk, Fenics is used for pricing, deal capture and portfolio valuation. Traders input options transaction details into Fenics and generate trade tickets that are passed to back-office staff for entry into a separate risk management system--Quotient Plc's TUFFS, (now known as ACT Financial Systems' CMARK) running on a DEC VAX minicomputer.

CMARK, in turn, is linked to the bank's central trade processing, accounting, and risk management system, MANTEC, from Management Technologies Inc., running on an IBM 3090 mainframe. CMARK handles trade processing for off-balance sheet instruments, while MANTEC handles cash market transactions.

Fenics is a PC-based system without links to real-time pricing sources such as those provided by Reuters Holdings PLC or Telerate Systems Inc. It generates options portfolio valuations based on information (e.g., spot prices, volatility and interest rates) input by traders. If a trader chooses to enter a spurious spot price, Fenics has no way of checking it against a live price data source. Also, traders can look up old trade tickets on Fenics and void them or adjust any trade details. This type of flexibility is typical of front-office position-keeping systems, which are designed to help traders sort out their positions, not for treasury control.

Sources close to the options trading desk say ABN-Amro called in Fenics support personnel last weekend on an emergency basis to help access FX options trade records. None of ABN-Amro's three N.Y. options traders were present during the exercise, the sources say. Peter Cyrus, president of Astrogamma, says "problems with our software [Fenics] played a negligible role in this situation."

ABN-Amro's acknowledgement that unauthorized trading occurred suggests that human error and/or fraud is the root cause of the loss. But improved system integration might have helped detect the problem sooner.

ABN-Amro's treasury control accounting unit uses its own set of assumptions to value the bank's off-balance sheet positions. Differences of opinion between accounting and trading departments over the value of forex options positions are not unusual. Sam Halim, senior vice president in charge of automation and administration at ABN-Amro in New York declines to say how frequently the treasury control unit compares options valuations with the trading desk, but allows that "any bank should compare them on a daily basis."

Discrepancies in valuation, according to Halim, should be limited to the amount the currency in which an options position is taken moves in one day. Without systematic, automated comparison of the trading department's book (as it appears on Fenics and CMARK) with the bank's official book (as it appears on Mantec) prompt detection of errors (or fraud) is more difficult.

Some sources close to the bank also blame Guarino, who one source says has been "stripped of all his authority" in the wake of the hit. "It was a case of Guarino not really monitoring his people that well, not really understanding the options business, and not really knowing what they had on, and then just basically putting in different rates of volatilities, so the data provided would show basically neutral P&L," a source at the bank says.

A spokesman at the bank's headquarters in Amsterdam denied those reports two weeks ago when the loss was first uncovered internally. Although the bank now acknowledges the loss, it declines comment on Guarino's role. Bank management continues to investigate the incident and so far hasn't moved to tell shareholders about the hit.

ABN-Amro's foreign exchange trading activities made a substantial contribution to overall earnings last year, and the bank has been building its foreign exchange department in the wake of the merger between the two Dutch giants. The New York loss may cause management to rethink its profile.

The loss follows news of a $23 million hit by Dai-Ichi Kangyo Bank's Los Angeles office and a $5 million hit by Morgan Guaranty's New York options desk (FX Week, December 13) and underlines the treacherous nature of the business. In all three cases, traders were reportedly involved in schemes to hide their errors and elude internal controls.

One source close to ABN says management and some of its top traders were in Amsterdam for a conference when the hit was initially uncovered. "They all hopped on the Concorde and came back the next day," this source says. In addition, "they escorted the options trader back because they were afraid he was going to leave the country."