NAB case study

NAB case study

What was the cause of the problem?

In January 2004 the National Australia Bank (NAB) made the following three public announcements relating to losses from the foreign exchange options transactions:

• 13 January 2004 - an initial announcement of losses from unauthorised foreign currency trading activities estimated at A$180 million.

• 19 January 2004 - an update of the losses was revised to A$185 million but with a statement that

they were not expected to exceed A$600 million.

• 27 January 2004 - an announcement that the total losses were A$360 million, which also included the impact of false transactions as well as a further amount of A$175 million arising from a revised revaluation of the trading book at 19 January 2004.

These losses occurred principally because of an increase in risk-taking in the currency options portfolio, and combined with adverse currency movements (particularly in the last four months of calendar year 2003 and early 2004). The overstatements of the currency options portfolio value at 30 September 2003 was A$42 million, and A$92 million on 31 December 2003; and the continued weakening in the US dollar led to an escalation of these losses in early January 2004 to A$185 million. A subsequent revaluation of the portfolio on 19 January increased the losses to A$360 million. The perpetrators of this scandal were four currency options traders - three in Melbourne and one in London - who were aware that significant trading losses had been incurred and concealed in 2002 and 2003, and in 2004.

The practice of smoothing profits and concealing losses had been undertaken by the traders for over two years, and possibly since 1998. The traders had concealed losses by entering various types of false transactions into their trading system. Various methods were used which exploited gaps in many controls. The key methods were: incorrectly recording genuine transactions, entering false transactions, and using incorrect revaluation rates.

How did it happen of the problem?

The NAB currency options team commenced trading in 1998 with three dealers, increasing to four in 2000 with a mandate to grow both customer business and proprietary trading income. Contrary to the strategy, in 2003, risk-based proprietary trading activity grew significantly. So too did the size of the book. At 30 September 2003 the notional principal of the currency options book was A$253 billion. Dealing decisions in the last quarter of 2003 resulted in a large long US dollar position against a range of other currencies. Major losses were incurred when there was a ten cent fall in the value of the US dollar against the Australian dollar. During interviews, the traders admitted that the practice of concealing losses (in some cases profits) and their true positions started sometime before October 2001. Initially, incorrect dealing rates were entered into the system by the traders in order to shift profits and losses from one day (or period) to another. This practice was referred to by the traders as 'smoothing' and appears to have been accepted practice by the currency options ...