A $1.1 billion bond trading loss at Daiwa Bank's New York office - allegedly the result of fraudulent activity by one employee over 11 years - is raising concerns among bankers and regulators about the oversight of trading operations.

Observers said the employee, executive vice president Toshihide Iguchi, could have carried out the trading only if there was no independent "middle office" reviewing his transactions.

The institution of such an office, sometimes referred to as "an independent risk management function" that reports directly to the bank's chief executive, has been recommended by bank trade groups and regulators for two years.

Mr. Iguchi was arrested in New York on Tuesday and charged with falsifying Daiwa's books and records to conceal losses from unauthorized trading in government bonds.

The alleged fraud is said to have begun in 1983, when Mr. Iguchi lost about $100,000 trading Treasury securities. According to a source close to the bank, Mr. Iguchi continued to "dig himself in deeper and deeper," making increasingly large bets to cover the mounting losses.

Mr. Iguchi had been in control of both the back and front office activities at the branch. Such an arrangement, observers said, would have allowed him to trade and then conceal negative results without intervention by another bank officer.

"The bank essentially had no internal control system," said L. William Seidman, former chairman of the Federal Deposit Insurance Corp. "Very clearly, the lack of internal controls helped him do what he did."

Lee Cross, a spokeswoman for the Office of the Comptroller of the Currency, added: "This reemphasizes something that we have been stressing - the need for independent controls on risk and on trading activities in individual banks."

Bank trading operations should have a back office, a front office, and a middle office, all reporting independently, emphasized William Ferrell, managing director of Connecticut-based Ferrell Capital Management, a consulting firm.

"It used to be that everybody trusted the people who worked for them," he said. But now, "the securities are more complex, the markets are much more volatile, and the balance sheets are much larger. You can't just rely on the trust of your people anymore."

Some observers maintained that regulators from the United States and Japan should have detected the alleged fraud at Daiwa. But a spokesman for the Federal Reserve Bank of New York, which monitors the U.S. operations of overseas banks, maintained that it acted properly.

"The primary responsibility for fraud lies not with examiners but with the bank and its auditors," said the spokesman, Peter Bakstansky. "A regulatory agency can't go in and do an audit - it does an examination. These are different things. We want to see if they are operating safely and soundly."

He added that the Fed referred the case to the U.S. Attorney's Office last week.

A trading chief at a major bank said he was stunned by how long the alleged fraud was said to have lasted.

"I have trouble believing you can fool anybody for 11 years," this executive said. "They had no independent evaluation in their back office."

Part of the reason the more than $1 billion discrepancy was never discovered was that it involved the trading of U.S. government securities, considered one of the least risky instruments available.

"People don't tend to focus their audit review on instruments that are considered less risky," said one observer. "On derivatives, we make double and triple checks. But people don't spend that much time on Treasury bills."

Olaf de Senerpont Domis, Barbara A. Rehm, and Jaret Seiberg contributed to this report.

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