During a subsequent review, the Allfirst risk-assessment analyst, who found out about this FX-pricing spreadsheet system, noted, "This is a failed procedure" and pointed out, "Technically the trader/s could manipulate the rates." When the risk-assessment analyst inquired about obtaining the rates independently, the treasury-risk analyst noted that Allfirst would not pay for a $10,000 data feed from Reuters to the back office. But the situation wasn't remedied until fourteen months after the first discovery that foreign-exchange rates were not coming from an independent source.
The Lehman case also comes down to fraud and cover up by an employee, but the employee in question was actually funneling money from client accounts for personal gain. Frank Gruttadauria's scam appears to have started when he joined Cowen & Co. brokerage in Cleveland in 1989. The firm was then bought by Societe Generale and became SG Cowen. Lehman bought the SG Cowen branch, where Gruttadauria served as branch manager, in October of 2000.
Gruttadauria's theft may have come as a surprise to Lehman and Cowen officials, who were alerted to problems when the broker failed to show up for work and disappeared for almost a month before detailing his fraud in a letter to the FBI and ultimately surrendering to law-enforcement officials. But the New York Stock Exchange had been investigating Cowen & Co. since 1998, when the firm was fined $380,000 and disciplinary action was taken for violations in 1994 and 1995. The NYSE found that Cowen & Co offices, including the Cleveland branch, had violated rules regarding the oversight of brokers. When the firm became SG Cowen, it agreed to make changes to its compliance procedures.
One sticky area, in particular, that indicates some of these changes may not have been made sufficiently, was Gruttadauria's dual role. He served as branch manager, while also acting as a broker and helping to supervise the compliance executive at the branch. In other words, Gruttadauria was charged with determining the compensation and filing performance reviews for the compliance officer who oversaw the brokers.
While the criminal investigation into the Gruttadauria case is keeping disclosure to a minimum, the Securities and Exchange Commission has already taken disciplinary action against Gruttadauria to freeze his assets in an attempt to recover money for investors.
According to the SEC charges, Gruttadauria, "falsely told customers that he had bought or sold securities for their accounts, when, in fact, he had misappropriated their funds for his own purposes."
The SEC complaint alleges that Gruttadauria sent unauthorized and false account statements that overstated the value of customers' accounts, reflected holdings that didn't exist and recorded transactions that never occurred. He also failed to disclose unauthorized withdrawals from the accounts. While the SEC has only taken action against Gruttadauria, not Lehman, the next step for the commission may very well be to look into the adequacy of supervision at the firm, says a person familiar with the case.
William Baker, associate director at the SEC's Division of Enforcement, agrees, "In any investigation where there has been misconduct by a broker, or any individual of a broker/dealer, we always look at supervision." While the outcome in the Gruttadauria case is still unclear, Baker says, "This is an unusual situation, in that the branch manager has taken a bunch of money from individuals."
So why was Gruttadauria able to perpetuate the theft? Alex Viall, chief editor at Complinet, which supplies compliance information for compliance staff and regulators, emphasizes the importance of internal and external audits in detecting these types of fraud. "It's key that auditors are changed on a regular basis," he says. "Because it's very easy to think, 'Well, I've been here before and it all looks the same and it's fine.' New, fresh eyes from the audit standpoint often start bringing up different queries." He advises that while it may be time consuming to bring new people in each year, it's a good idea to change auditors that often. In addition, Viall says that experience is vital and that auditors need to have an understanding of the market and know the products they are overseeing.
Additionally, firms should not be looking to cut corners or costs on oversight and compliance, two areas that should have prevented Gruttadauria's scam, says Viall. "The commitment to good compliance staff and good systems is improving but there are still some firms that see compliance as a pure cost," he adds. "And it's going to cost them more in the long term, whether it be through regulatory failure, fines and the like, or reputation damages." Phone calls to Lehman's spokesperson were not returned at press time.
Closing the gaps
Capco's Owen says that, moving forward, the key to avoiding the types of losses that occurred at Allfirst and Lehman is "some very boring examination of detailed processes, looking at where control points are and making sure the right oversight is in place." He adds that while automation helps to control the oversight, it's important to take the business logic into account. "This is why operations risk is so complex, in terms of having to think about it rather than just using auditors or accountants to tick things back, you have to understand the processes."
But having automation and quality front-office systems in place is important nonetheless, points out Meridien's Williams. "If firms are only relying on paper, or other sorts of imprecise processes, then skirting them is easier," she says. Her advice is that firms should have a lot of internal reconciliations in place, as well as internal check points, to catch any unusual activity.
Williams sums up the reasons behind complacency and lax control and says, "Wall Street is very bad at questioning people who are making money. They're good at beating up on people who are losing money for the firm, asking them why they're losing, how much and how they got there."
Although Allfirst declined any interviews for this story, the bank did issue a statement and outlined some changes that are being made in its organizational strategy and group structure. Susan Keating, president and chief executive officer of Allfirst, stated, "We've learned some painful and important lessons ... we are squarely focused on moving forward to implement Mr. Ludwig's recommendations and to build on the strengths of the Allfirst franchise."